Adam Posen -- The Shape of the Recession

Sunday, April 19, 2009

A hot debate among economists in Washington -- yes, there are such things -- involves the future shape of the United States' recession, now 16 months old and counting. Will it be V-shaped, as in a steep decline followed by a rapid recovery? How about U-shaped, with a longer downturn and slower upswing? Or even L-shaped, featuring a quick plunge that flatlines forever?

An alternative forecast taking hold around town sounds (but only sounds) like a swipe at the former president: the W-shaped recession, in which the economy falls and bounces back quickly, only to decline again.

In a recent podcast from the Peterson Institute for International Economics, deputy director Adam Posen explains why our future looks like W. First, even after the fiscal stimulus and the home refinancing frenzy work their way through the economy, the nation's banks will still be in a bad way. Despite the administration's efforts, banks won't lend as much as they should and will postpone their day of reckoning by simply rolling over bad loans. That portends another banking crisis "a year or two down the road," Posen said.

Second, even forgetting the banking troubles, the American economy is not what it used to be, with productivity and the labor force growing more slowly. So the economy may not even be able to grow as fast as it did a few years ago. In that case, an economic recovery could spark inflation, Posen argues, and the Fed would clamp down by hiking short-term interest rates, choking off growth.

President Obama has spoken of "glimmers of hope" in the economy, and a Fed report last week found signs of stability in some regions of the country. Posen concurs that growth could resume as early as the fall -- but maybe not for long.

"Everybody's picking up a letter in the alphabet," Posen said. "Despite the bad association of it, I'm in favor of the letter W, which is that we get a bounce now, but very quickly thereafter we go back down again."

-- Carlos Lozada

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