By any definition, we are in a recession. The prospects for a quick recovery in 2009 are bleak, even with a massive Obama-led fiscal stimulus package and a Bernanke-led monetary stimulus.
Using a relatively new flexible definition, the National Bureau of Economic Research (NBER) said that the current recession started in December of 2007. The NBER recession dating committee is a small group of highly skilled academic macro-economists at various universities who decide when recessions begin and end.
Since approximately 1946, the definition of a recession was based on two successive quarters of declining real GDP. This meant that it would take at least six months to know if you are in a recession. Indeed, the 2001 recession was not a recession by the old-school definition. Since most everyone thought it was a recession, the committee decided to use a new expanded definition based on monthly rather than quarterly data.
The NBER dating committee now uses five monthly measures: (1) real personal income less transfer payments; (2) employment; (3) industrial production; (4) real sales in the manufacturing and wholesale-retail sectors; and (5) estimates of real GDP. Even though real GDP rose in the first two quarters of 2008, the committee placed most of its emphasis on declining employment data even though some of the other measures held up for first half of 2008.
It was expected that monthly data would speed up the dating of a recession. That hope has not realized as it still took until December 2008 to say that a recession had started in December 2007. Monthly data has failed to quicken the lag time between the start of a recession and its announcement as it took 13 months, rather than six or seven months to know when you are in one. Nevertheless, since the third and estimates of the fourth quarters of 2008 indicate declining real GDP, even by the old definition, we are now in an official recession.
No swift end
Since monthly payroll employment data seems to predominate in the minds of the NBER recession dating committing, the prospect for a swift end to this current recession is quite bleak as employment is likely to continue to decline. Employment declines began first in the construction industry due to the housing market slump that will persist in 2009 with further foreclosures and further declines in housing prices. Next, industrial employment began to decline as the credit markets were disrupted and even international trade was slowing. A quick improvement in world trade is not anticipated.
We have now entered a period where even service employment is declining. Restaurants, bars, hotels, and stores are all retrenching for the slowdown in their businesses. The closing of stores, bars, restaurants and hotels will continue in 2009, which will increase the number of the unemployed. The closure of Heinemann’s Restaurants is only one reminder of the continuing cut-backs and closures that are occurring.
The single hold out from this trend has been government employment, especially in education. But even that will begin to decline as states and municipalities find that their budgets are in the red. School districts and colleges are holding back on replacing retired employees, which should show up in 2009 as a net decline in government employees for the first time for many years.
To visualize this forecast for employment, imagine a playground slide at a park, with the steepest decline at first and a slower decline near the bottom. We are still in the steep decline mode, and the slowing decline will occur as the year progresses.
Unemployment is forecasted to rise throughout 2009, not just for the first half, but will rise for the whole year. Even as the number of new weekly claims for unemployment will begin to decline as the year progresses, the total number of those unemployed will continue to rise this year. A further extension of the period in which people may collect unemployment will surely be increased from 39 to 52 weeks by the next Congress, which historically has tended to lengthen the average duration of unemployment. Modeling historical data leads to a prediction that the total number of unemployed in the household survey will rise from 10.3 million to 13.8 million by year end 2009.
With rising unemployment, we will begin to see unemployment rates not seen in the U.S. since 1983, and will likely reach 9.1 percent, not quite reaching 10.4 percent found in 1982. Unemployment will gradually rise from 7.2 percent to 9.1 percent by year end, with much of the increase in the first half of 2009. The peak unemployment rate of 9.1 percent is somewhat lower that in 1982 because the age distribution of the labor force is older, which tends to reduce the unemployment rates. The forecast uses an updated version of Okun’s Law using a prediction of a 2 percent decline in real GDP.
Some economists are expecting (or perhaps hoping) that the worst is over, and that an Obama-led economic stimulus package will lead to a fast turnaround later in the spring. His stimulus plan with some modifications will pass and will include a combination of federal infrastructure projects, tax cuts, tax credits, and incentives for specific green projects to try to jump start the economy.
President Barack Obama has signaled that he favors a two-year plan in the $825 billion range, which is indeed larger than the Bush stimulus plan last spring of $168 billion.
However, the Obama plan will take time to be implemented. It will have the surprising unintended consequence of reducing the total amount of public projects undertaken this year. The reason for this unexpected outcome is a form of crowding out of some public projects by other public projects.
A new form of crowding out
In times of full employment, “crowding out” is a term applied to the problem of government projects crowding out private-sector investments, where monies spent on public projects prevent private ones from being funded. But we actually have a series of overlapping layers of federal, state, county, and municipal governments. The stimulus package reveals how one layer of government impacts other layers.
Suppose that $100 billion or more is spent on federal infrastructure projects in 2009. If these were all new projects, this is surely an economic stimulus. But suppose that most of these funded projects are projects that states were planning to do in the first place – fix roads, repair bridges, improve water treatment plants, etc. States with dozens and dozens of these projects on the drawing boards now stop all of these projects awaiting the hope that the federal government will pick up the tab for them.
If a road or bridge repair is paid for by the federal government that would have been done by the state government, then we are seeing a form of crowding out of one entity by another. This creates no net stimulus. The promised stimulus is thus a net decline if dozens more projects by the states are shelved in hopes of being funded in the second year of the stimulus package.
Imagine that you had a garage door that didn’t work and you wanted to fix it or purchase a new one. If you thought that someone else might pay for it, wouldn’t you wait to see if that would happen?
Right now, this wait-and-see attitude stifles the housing markets, as buyers think maybe housing will get even cheaper. Potential car buyers wonder if they wait, will there be a government-sponsored plan to purchase cars for even less?
Each industry that seeks a bailout is often held hostage to finding out what will occur. One of the best things that will happen in the first months of the Obama administration will be to clarify what actions will occur to reduce policy uncertainty that has stifled many economic units from completing their plans.
A brief up-tick
Suppose that the Obama plan is passed in early weeks of the new administration. Portions of the plan will include tax credits or rebates to consumers. This was done in early 2007 and helped push up the GPD in the second quarter into positive real GDP growth. I expect that we will see some quarter or quarters in 2009 with positive real GDP growth, thanks in part to the massive fiscal stimulus package.
This upward blip or up-tick in GDP will be more of pimple in a flat or declining path for 2009. As the unemployment rate continues to rise even as GPD picks up, consumer sentiment will continue to be low.
An increase in GDP for a couple months will make some will think that the recession has ended. But later in the year a second "double dip" recession returns as unemployment and foreclosures continue to rise. Indeed the recession in 1980 and 1981-82 was very much a double-dip recession. The economy is metaphorically a swimmer that is underwater. For a moment the economy comes up for a breath of air and then dives back under water in a double-dip recession.
The 1980-extended double dip recession was impacted by a severe credit crunch as the Federal Reserve in late 1979 began to tighten the growth of money. Our current recession is also tied up in a credit crunch as major investment banks found that some of their lending had much lower credit worthiness than they thought. While these two time periods are quite different in the particulars, if a forecaster is to use history to help form a forecast, the time period of 1980-1983 eventually turned around with major federal spending and especially a major tax cut. The period 2007-2010, will likely take as long to right itself.
It may surprise investors that stock market returns can be positive in the middle of recessions. Even amidst the Great Depression, the Dow Index rose 66.7 percent in 1933 and 38.5 percent in 1935. The reason we find this occurring is that the stock market is looking ahead to the future. Even if unemployment rises in 2009, firms are using this as an opportunity to close their worst performing products and stores to reduce costs. When an eventual economic turn around does occur, they are in a more favorable position to profit from it.
So even if it takes until 2010 for an economic recovery, the brutal stock market declines of 2008 make it more likely that we will see positive returns in 2009 looking ahead to 2010 and beyond. Because of the bleak employment picture, these positive returns may be modest, but if investors wait until a recession is completely over to invest, they typically miss a major portion of the bounce back in equity values.
Monetary policy has been surprisingly stimulative. The Federal Reserve has cut the target federal funds rate (the rate member banks lend to one another) to a range of 0-.25 percent. This low level is unprecedented. It is a sign that the Federal Reserve wants to extend money to the banking system. With rates this low, you would expect a flood of new borrowing, but that has not yet occurred.
It is easy to get testy with bankers for not wanting to lend more, but put yourself in their shoes. Suppose that the economy ahead looks bleak, that housing prices are still falling, and that you have lost money on other loans. Your brother-in-law comes to you to borrow the $5,000 you have in your savings account saved for a rainy day. Would you loan it to him? Maybe you will need it. Banks are behaving this way. You can extend offers to banks to borrow at great rates so that they could lend out more, but they are trying to improve their capital structure and avoid past mistakes.
The Fed can’t force banks to borrow more and then lend more. To understand this point, suppose that you have an obstinate puppy, you make him move if you pull him with a leash. But if you push on the leash, the recalcitrant animal will stay put. The current monetary stimulus will really take hold when banks decide to open up their own checkbooks.
The shell game
We hope that then next round of federal stimulus expenditures gets the economy moving, but there is a very real possibility that what tax cuts or rebates that Washington, D.C., offers, our state capitols, counties and cities will take away. Tax cuts are simulative; however, with every city and state facing revenue shortfall, states and other taxing districts are proposing a myriad of new taxes or fees.
Taxes and fees are already rising across the county. The Milwaukee Public School System just raised it property tax levy by 14.6 percent, and many states and counties will be raising property, income and sales taxes.
Suppose that the federal government lowers your taxes in the stimulus plan by $1,000 but your local and state property taxes and/or sales taxes rises $1,000. Where is the stimulus? What one hand gives another one takes away.
The year ahead
So, prepare for an unsettling elongated recession, one that in total length is over two years in duration even if split up into two successive recessions. While a massive federal stimulus may show a temporary upward blip in economic activity in late spring, the path this year is a protracted slide down a long road of bad employment and worsening unemployment news.
Richard Marcus, Ph.D., is an associate professor of managerial economics and finance at the Sheldon B. Lubar School of Business at the University of Wisconsin- Milwaukee.