Is the Recession U shaped?

On a day when the unemployment rate spikes by half a percentage point, we may be past questioning whether a recession in the U.S. is here. A month ago, Noriel Roubini framed the question smartly:

In principle, the US recession could end up being shaped like a V, U, W, or L. Which of these four scenarios is most likely? The current consensus is that the recession will be V-shaped – short and shallow – and thus similar to the US recessions in 1990-91 and 2001, which lasted eight months each. Most analysts forecast that GDP will contract in the first half of 2008 and recover in the second half of the year. I expect a longer and deeper U-shaped recession, lasting at least 12 months and possibly as long as 18 months – one of the most severe US recessions in decades – because today’s macroeconomic and financial conditions are far worse.

Now on the spectrum of macroeconomic analysis, growth sits on the long-term end of the spectrum, whereas recession-watching is on the short-term end. This is my way of saying, growthology.org really shouldn’t be commenting on the recession stuff … too small ball. So here’s my justification:

1. I’ve published on this topic recently. My little model - the employment recession indicator – says the recession probability is in the 50% range. It will go higher (and I’ll believe the recession has spread from financial markets to the real economy) once initial jobless claims rise above 400,000 consistently and unemployment goes to 6.0%. That may happen soon, and when it does, count me among the bears. But UI claims remain too low for a recession, and they tend to be early warning signals.
2. The specter of the Great Depression haunts any public conversation about economics, which includes this blog. And lest we forget, momentous shifts in popular and professional thinking occurred during the 1930s. In particular, the breakthrough work of our patron saint (Joseph Schumpeter) was notoriously overshadowed by the breakthrough work of JM Keynes.
3. I dislike historical parallels such as “This recession has signs of becoming another great depression” because (here’s a Kane mantra) Growth Trumps All Historical Parallels.

No, America is not analogous to a new Roman Empire. No, the housing meltdown is not akin to 1929’s great crash. Technological dynamism makes modernity so different from previous eras that no parallel really works. To clarify the larger posturing, ask yourself this: what is more important to contemporary affairs: hegemony, terrorism, or technology? Answer: technology. What’s a bigger deal in the sweep of history: asset bubbles or technology? Answer: technology. Point being, I doubt the upcoming political debate of 2008 - which will focus on short-term economics and the War on Terror - will address the most important issue of technology acceleration and its implications.

Remember when the NASDAQ crashed and the media said, “The New Economy Was an Illusion.” They were wrong. The Internet’s still here, folks, bigger than ever. The bottom line is that changes wrought by technology are VERY real, with both good and bad consequences. It is the topic that no grand strategist, or politician, or pundit should be allowed to ignore.

Now, Roubini might agree with me on all that. But I was still skeptical about the recession ever being called, until this morning's employment report. My best guess remains that it won’t be V or U or L or W shaped. I’m looking for letters on my keyboard to represent my prediction. Ah, here it is:

0 (as in null set)

I think aggressive Fed action on interest rates will be very effective in the short term (albeit inflationary). I doubt housing assets have declined enough to shake the lifecycle consumption smoothing habits of Americans, meaning GDP and the real economy will stagnate but not recess. I do worry about oil prices, but anticipate/hope/pray for that commodity speculation to pop. And ultimately, I think innovative entrepreneurship and consequently potential GDP are accelerating. My worst case scenario has a deep U-shaped recession that masks productivity growth for a year or two, followed by a booming catch-up to potential GDP in 2010-12 … plus lots of inflation.

Hat tip: RealClearMarkets

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Tim: As I wrote on my blog, Truth on the Market, I think Tyler is pretty far off base with this one. See http://www.truthonthemarket.com/2009/04/28/what-does-tyler-know-about-law-and-economics-anyway/

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