Saturday 21 Jul 2018 | 16:21 | SYDNEY
Saturday 21 Jul 2018 | 16:21 | SYDNEY

Green shoots, second derivatives and history lessons


Mark Thirlwell

22 April 2009 09:25

In the five or six weeks from the start of March, there was a surprising burst of (equity market) optimism regarding the global economic outlook. Suddenly, it seemed, the end of the Great Recession might be in sight. 

US and global economy watchers had spotted a few of US Federal Reserve Chairman Ben Bernanke’s famous ‘green shoots’ of economic recovery and decided it was time to go bottom fishing, prompting a mini stock market rally. By Monday, however, there were signs that at least some of this optimism was being reversed. So how is the global economy travelling right now?

For some, the US data flow in recent weeks seemed to provide reasons for hope: in a speech last week, Bernanke himself highlighted ‘tentative signs that the sharp decline in economic activity may be slowing, for example, in data on home sales, homebuilding, and consumer spending, including sales of new motor vehicles'. 

Meanwhile, in Asia, optimists looked to the latest set of Chinese economic statistics. Sure, the outcome for first quarter GDP may have been the weakest since China started reporting quarterly data. But those in search of a silver lining could point to signs in the numbers for bank lending and fixed investment that Beijing’s stimulus policies were getting some traction, in turn prompting hopes for a stronger Chinese economic performance in the second half of this year.

Much of this optimism could be boiled down to a hope that the so-called ‘second derivative’ had turned positive:  that is, that the rate of economic decline has started to slow. But this is just another way of saying that, at best, things may be getting worse more slowly, as opposed to actually getting better. And it’s probably worth remembering that, according to Nouriel Roubini, over the past two years 'the stock market has predicted six out of the last zero economic recoveries — that is, six bear market rallies that eventually fizzled and led to new lows'.

One reason for exercising a large amount of caution about the prospects for any kind of swift economic recovery is provided by a new piece of analysis released by the IMF last week. Fund economists have conducted a study of recessions and recoveries in 21 advanced economies over the period since 1960, a sample which includes 122 completed and 15 ongoing recessions. Their results are summarised in their Table 3.1, but three key points are worth emphasising:

1) Recessions associated with financial crises tend to be longer and more costly than others. Financial crises also tend to be followed by weaker recoveries than those that follow other types of recessions. Of the 122 recessions in the Fund’s sample, 15 were associated with financial crises.

2) Highly synchronised recessions — defined by the authors as recessions during which 10 or more of the 21 advanced economies in their sample were in recession at the same time — tend to be longer and deeper than other kinds of recessions: the average duration of a synchronous recession is 40% greater than that of other recessions, for example. In addition to the current cycle, there have been three other episodes of highly synchronised recessions: in 1975, in 1980 and in 1992.

3) Finally, recessions that are associated with both financial crises and global downturns have been unusually severe and long-lasting, and subsequent recoveries have tended to be weak. According to the IMF study, since 1960 there have only been six previous examples of this nasty combination: Germany in 1980; Finland and Sweden in 1990; and France, Greece and Italy in 1992. On average, these recessions lasted almost two years and saw GDP fall by more than 4.75%.

All of which, of course, has uncomfortable implications for the current economic crisis, combining as it does a dramatic financial crisis with a global recession (the Fund reckons that by the end of last year, 15 of the 21 advanced economies had already fallen into recession). According to history, then, we are in for a long, deep recession followed by a slow recovery — a gloomy conclusion which is in line with the findings of a similar study by Carmen Reinhart and Kenneth Rogoff.

Photo by Flickr user Dave Ward, used under a Creative Commons licence.