Tuesday, May 18, 2010

SF Fed: Current Recovery Stronger Than Past Two Recoveries

An article by Weidner and Williams in the Federal Reserve Bank of San Francisco Letters states that the recovery from the most recent recession is likely to be faster than from the two previous recessions, but slower than earlier V-shaped recoveries.

The paper cites three major factors that will affect the growth rate of real GDP coming out of a recession – the degree of slack in the economy, the stance of monetary policy, and the trend growth rate of potential GDP. The greater the degree of economic slack, the more accommodative the stance of monetary policy, and the higher the rate of growth in potential output would contribute to a stronger pace of economic recovery coming out of a recession.

During the post-war period prior to 1990, the U.S. economy tended to bounce back relatively briskly from downturns. During the first 8 quarters after the economic trough, pent-up demand added about 1 percent to real GDP growth, monetary policy about .9 percent to real GDP, and potential output growth 3.6 percent.

However, during the recoveries from the last two recessions, these three factors made smaller contributions to real GDP growth. That is why these recoveries had a U-shaped, instead of a V-shape that was associated with earlier recoveries.

Weidner and Williams estimate that the current recovery will be stronger than the past two recoveries; because there is greater level of economic slack and pent-up demand in the system and monetary policy is very accommodative. However, the large unknown is potential output growth. Weidner and Williams are modeling potential output growth’s addition to real GDP growth of 2.1 percent; but the Congressional Budget Office is estimated that its contribution to real GDP growth will be closer to 1.6 percent. If the latter estimate holds, the recovery will be more U-shaped, while the former estimate will point to a more V-shaped expansion.

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