What will economic recovery look like as the world emerges from Covid-19? Given that the coronavirus pandemic and associated shutdown measures are unprecedented in living memory, it’s unsurprising that economists are exploring new patterns to describe how businesses and households will come out of this crisis. In this short video, courtesy of BizNews partner the Wall Street Journal, leading economists explain current thinking on why the old rules of recoveries may not apply. – Editor
If you watch the news, you’ve probably been hearing about alphabet economics.
V Shape. That V shape. The W shape the U shape or the dreaded L shape.
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This is how economists talk about economic recoveries, and it’s not just jargon. These letters drive policy decisions, Congress and the central bank. Decisions that can help determine how far we fall and how quickly we rebound. The coronavirus downturn is different from past recessions. In fact, it’s so different that economists are having to come up with new shapes to describe the potential recovery. When economists study a rebound, they often look back at previous recoveries for insight. Look at 1953. In the midst of an economic boom, the Fed raised interest rates to prevent inflation and the economy saw a sharp contraction, followed by a quick recovery in 1954, this is the V.
Jon Hilsenrath: V is preferable. What it means is that right after you have the downturn, you bounce right back. In a V shape recovery. We would get back to the previous high of GDP and the previous low of unemployment within a matter of months instead of a matter of years.
Experts say it’s possible that we could see a V-shaped recovery from the current recession.
Jon Hilsenrath: There were early signs that we got in May suggest that we were bouncing back from a very deep hole. There is a chance people just come back and try to get back to business. Some of their income has been replaced by the government, by government paycheques. So they could come right back, but it’s not a certainty.
Jump ahead to the early 1980s when the Fed pushed interest rates higher to battle inflation. The GDP dipped down in 1980, spiked back up and then plummeted even further before recovering at the end of 1982, this formed a W-shaped recovery.
Jon Hilsenrath: The Fed was pushing up interest rates to get inflation down, but it didn’t work. They had to go back at it and it wasn’t really until the end of 1982 when the Fed was in a position where it could cut interest rates aggressively and get the economy back on track again. The Fed is in a different position this time because they’ve cut interest rates very aggressively already. There’s no inflation on the horizon.
If we see a W this time, it will likely be for different reasons, tied to the coronavirus.
Jon Hilsenrath: If the second wave comes in and people stop going out and factories have to shut down again and governments start putting on more restrictions that could stall the expansion that we started to see in May and June.
There are other options to look at 2009, at the period following the last financial crisis, the economy declined steeply when the housing bubble burst and took nearly two years to recover. This is known as a U. Shaped recovery.
Jon Hilsenrath: What could cause a U shape recovery this time, is you have to come back to the coronavirus. If we continue to see high caseloads and high hospitalisation rates, it might be that people are very slow to get back to business normally and that we just don’t climb out of this very quickly.
Those are the traditional shapes of alphabet economics, but again, this downturn is different. Economists are looking at other shapes to try to describe it.
Jon Hilsenrath: Our economy got hit by an outside shock, the Coronavirus and we just shut it down. It was almost like a meteor hit the economy.
One of these shapes is the swoosh, where the economy falls quickly, rebounds a little, but then takes months or even years to recover fully.
Jon Hilsenrath: I think what would cause a swoosh like expansion is that all the uncertainty that comes out of what we just experienced, the way people think about, for instance, do I want to live in a city anymore, the way a business thinks about, do I want to invest in an urban area or someplace where it might be safer or not as congregated. It takes years potentially for people to get back into our comfort zone where the economy is functioning at its full capacity.
It may take even longer than that. Some economists say this recovery could look more like a reverse square root sign where it drops and then rebounds partially before flatlining for a prolonged period of time. If you look at the economic activity index from earlier this year, you can kind of see it. It dropped sharply in March and rebounded partially before appearing to start to flatten out, but it’s too soon to say if it will flatline.
Jon Hilsenrath: I would say reverse square root sign would mean in the early stages of the recovery. A quick bounce back and we have seen that in May and June. But then as it proceeds, it flattens out. So we don’t get all the way back to where we were because businesses and households come out of this less willing to spend and invest because the coronavirus doesn’t go away.
The path of a recovery isn’t just an abstract shape. It helps policymakers determine how much stimulus money to pump into the economy.
Jon Hilsenrath: If the Fed was confident that we were going to have a V-shaped recovery, then they would start raising interest rates sooner than they otherwise would. They would stop doing their bond-buying programmes sooner than they otherwise would. If they think it’s going to be a long and slow and drawn out recovery that holds down inflation, then they’re going to keep interest rates really low for a longer period of time. It’s fundamentally important because if the Fed is determined to hold down interest rates because it thinks it’s going to be a slow recovery, then that will hold down the rate that you pay on your mortgage. That’ll hold down the rate that you pay for a car loan.
To protect millions of unemployed Americans. The Fed has signalled plans to keep interest rates close to zero through 2022.
Jon Hilsenrath: The worst casualty economically in a recession is the person who loses his or her job. This affects everyone who’s out of work and wants to get back on the factory floor, wants to get back into the restaurant, wants to get back in the office.
Congress’s decision about whether to approve more economic relief for these workers will depend on the shape of the recovery. As the coronavirus cases rise across the country, that sheep remains uncertain.
