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Deciphering the Shape of Economic Recovery

June 23, 2009 at 6:40 PM EDT
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When economists discuss economic recovery, it's often in terms of the alphabet. In the latest installment of his Making Sen$e series, Paul Solman explains what phrases such as "V-shaped recovery" or "U-shaped recession" say about the economic outlook.

PAUL SOLMAN, NewsHour Economics Correspondent: For the past year or more, the U.S. and global economies have been in the soup. And increasingly, the shape of a recovery is being framed in terms of the alphabet all over the world.

The most positive shape is brought to you by the letter V.

ANALYST: Well, certainly the view that it is going to be a V shape…

PAUL SOLMAN: Another form of recovery is described by the letter U.

NOURIEL ROUBINI, Chairman, RGE Monitor: … a severe U-shape recession…

PAUL SOLMAN: Or maybe the U is really an L.

MICHAEL MUSSA, Peterson Institute for International Economics: Well, the difference between an L and a U is in the eyes of the beholder.

PAUL SOLMAN: Or maybe it’s the letter W.

ROBERT RENNIE, Currency Strategist: It feels like we’re in a W-shaped recovery.

PAUL SOLMAN: Or the shape could be a little more sophisticated.

GEORGE SOROS: What I expect is an inverted square root sign.

PAUL SOLMAN: An inverted square root sign? We’ll get to that, too, because, in fact, picturing the possible shapes of a recovery may be a helpful way to understand the possibilities. So we visited friend Simon Johnson, former chief economist at the IMF, at his MIT blackboard for a bit of drawing and drawing out.

V-shape recoveries

PAUL SOLMAN: So what does a V-shaped recovery look like?

SIMON JOHNSON, MIT Sloan School of Management: Let me show you like this. So here's GDP, gross domestic product. That's output, what we produce, and here are years. And let's start, let's say, 2002. And maybe we'll run it out to 2012, which is further than we can probably see.

The economy is growing like this. This is the recovery from the dot-com crash. And now we hit a problem. We know that we've lost a lot of GDP. If we're a V, we go right back to the path we had before and you get a V-shape recession. And by the time, you know, you reach end of '09, 2010, you've forgotten about it, right? You bounce right back.

PAUL SOLMAN: Michael Mussa, also once a top IMF economist, is among the V-shaped optimists.

MICHAEL MUSSA: The only basic rule is deep recessions are followed by steep recoveries. That's precisely what a V-shaped recovery is.

PAUL SOLMAN: V for victory, if you will. If you believe it, that is. Mussa does.

MICHAEL MUSSA: We are undoubtedly having a very deep recession. And I think, as in the recovery from the recession in the early 1980s, the Reagan recovery, that I anticipate a far steeper recovery than most economists do.

PAUL SOLMAN: Economists like Simon Johnson.

Now, I remember you talking a while ago about an L-shaped recovery. So what's that?

SIMON JOHNSON: So take the same space, right, and have the same growth ahead of time. We have a sharp collapse, and then nothing happens, no growth. How long does that go on?

PAUL SOLMAN: And that's what you call the lost decade?

SIMON JOHNSON: Well, if we're really unlucky, it could be a decade. That's what happened to Japan. We don't know how long this goes on. You just don't bounce back; you don't have the recovery.

Opposing views on recovery shape

PAUL SOLMAN: Not for the length of this graph anyway, as young folks might put it, a loser economy.

The other main champion of the letter L besides Johnson has been NYU's so-called Dr. Doom, Nouriel Roubini, who's been slightly less alphabetically morose of late because of stimulus and bailout efforts worldwide.

NOURIEL ROUBINI, Chairman, RGE Monitor: I would say that the light at the end of the tunnel is that, given the very aggressive actions by the government U.S. and abroad, they're using the bazooka, the rocket, everything, monitoring fiscal credit policy, we're going to avoid a near depression. I think the probability of a near depression, the L is now being reduced. We'll still be in a severe U-shaped recession.

PAUL SOLMAN: But there are all kinds of views, some with short bottoms, some with longer ones. And the longer the bottom of the U, the longer the financial bath we all wind up taking, which brings us to Simon Johnson's favorite shape for describing the recovery...

SIMON JOHNSON: The bathtub.

PAUL SOLMAN: A U so long it might as well be an L.

SIMON JOHNSON: You go in. You stay in. The sides are slippery. You know, maybe there's some bumpy stuff in the bottom, but you don't come out of the bathtub for a long time.

PAUL SOLMAN: Michael Mussa thinks Johnson is all wet.

MICHAEL MUSSA: The L-shape really presumes that we're going to see something we have not seen in past business cycle history in the United States, where you have a sharp downturn and then you don't get any significant bounce-back from inventory investment or the recovery of residential investment from extremely depressed levels. That has simply not been the way things have ever worked in the past.

Stages of recovery

PAUL SOLMAN: But as they're obliged to confess on Wall Street, past performance is no guarantee of future results, as viewers were reminded recently on what some might call the Wall Street channel, CNBC, like currency strategist Robert Rennie.

ROBERT RENNIE: This to me is -- it feels like we're in a W-shaped recovery. It feels as if we're now at the apex of the middle, and it feels as if the next leg is potentially back down again.

PAUL SOLMAN: So growth, down, up, down, up, again in a very long time.

SIMON JOHNSON: That's a real possibility, particularly because the fiscal stimulus can give you a bounce-back, but may not be sustained, so then you go back down again. That's a W.

PAUL SOLMAN: By this time -- you'll be relieved to hear -- we were running out of alphabet, which is where George Soros and square roots enter the picture.

GEORGE SOROS: What I expect is an inverted square root sign, if you can...

ANALYST: You have to -- you have to draw that out.

PAUL SOLMAN: So we're growing and, bang, we go down. We come up a little bit, but then we stop growing. And who knows how long it's going to last?

SIMON JOHNSON: This is a definite possibility. We've come down so far and so fast that there's got to be some sort of rebound, call that a technical rebound, but then it could go flat. And flat means lousy growth prospects just like in my L.

'Not going down to zero'

PAUL SOLMAN: But don't we believe all the green shoots of recovery supposedly sprouting up these days, higher stock prices, more housing starts, lower rate of job loss? Aren't they harbingers of an upturn?

No, say the pessimists out there. Consider commercial real estate. Since the recession began, payroll employment has fallen by some 6 million people. Almost all presumably occupied office or factory space. Given the usual estimate of 175 square feet per worker, that's 1 billion square feet of newly vacant real estate, not to mention all the foreclosed homes that banks have yet to put on the market, and all this in the context of consumers and businesses that have drastically cut their borrowing and spending.

The blizzard of bad news then might suggest one last shape. Associated with, among many others, the much-lettered rock group AC/DC, famous for an album from the recession of 1979, "Highway to Hell."

No, not back to the letters, but to the symbol in the middle of them, a lightning bolt.

What about something like this, going up, go down, come up a little bit, keep going down?

SIMON JOHNSON: That is too pessimistic even for me. We have a continent here. It's a big country. We're not going down to zero.

PAUL SOLMAN: Maybe not, but then, given the difficulty the economics profession had in predicting that we have wound up in the soup, it's no wonder they can't come up with a consensus shape as to how we'll get out of it.