Patterns Of Recession
In the early days of her marriage, my mother tried to achieve the almost impossible goals established by society for a 1960s wife. Apart from tending to the needs of my somewhat Victorian father, she did her best, on an inadequate allowance, to keep herself and a growing family fed and clothed. Dutifully following the dubious home economics doctrine of the time, she would stew up great vats of jam and made some attempts at growing vegetables in the back garden. In addition, rather than buying a new dress, she would often make one herself, picking up a pattern and fabric at some store in town. The pattern was printed on tracing paper, and she would lay it out on the carpet, and then set to work with scissors and pins.

The whole process was very mysterious to me as a child, (as it still is now), but I remember vaguely thinking that the dress-pattern business was a bit of a racket. After all, my mother was a certain shape. Why would you need all these different patterns to fit her? But different they all were, and each dress presented a new challenge to my mother, which she met with youthful energy and her characteristic enthusiasm. 

Since the onset of the COVID-19 crisis, one of the most frequent questions I have been asked is about the pattern of this recession. Most typically, I’m asked to pick a letter.  Is it “V-shaped,” “U-shaped” or “L-shaped”? Given these crude choices, the answer is pretty straightforward—it is “U-shaped.” That is to say, the economy has fallen into a deep recession, will remain in very bad shape until the distribution of a vaccine, and should then see a surge in activity.

However, it is becoming increasingly clear that none of these letters does an adequate job of characterizing the likely shape of this experience. Because of the severity of the initial shutdown and the attempts to partially reopen, a more accurate description would include a slump, a bump, a crawl and a surge. Moreover, while this pattern is likely to be repeated across output, employment, profits and inflation, it will look a little different across each of these variables. For financial assets, as with my mother’s dresses, it is these differences in patterns that will make all the difference in outcomes.

A Pattern For Growth
The extent of the initial GDP slump should be further clarified by data due out this week. First quarter real GDP may be revised to show a slightly milder loss than originally reported. However, the second quarter will be epically bad.

Consumer spending may have fallen even more in April than in March, with widespread losses across discretionary goods, restaurants and a host of leisure, entertainment, travel and personal services. That being said, the last few weeks have seen a partial reopening and this, combined with the impact of stimulus checks distributed in April and May, should allow for a substantial bump in consumer spending in the third quarter. Thereafter, however, recovery should slow due both to the difficulty in supplying consumer services while observing social-distancing protocols and a lack of demand caused by health fears, cancelled events and the uncertainty caused by a deep recession. It will only be in the aftermath of the widespread distribution of a vaccine, hopefully in the first half of 2021, that consumer spending can begin to surge back to pre-recession levels.

Home building, likewise, will probably rebound in the third quarter following a second-quarter slide, as most construction workers resume activity with some social distancing rules in place. However, the housing market is likely to be soft throughout the recession due to economic uncertainty, health fears among buyers and sellers and weak demographics.

Business fixed investment is also taking a hit, as will be evidenced by Thursday’s durable goods report. As with consumer spending, this partly reflects supply difficulties. However, beyond this, investment spending will be battered by falling global trade, low oil prices (reducing the demand for energy infrastructure), weak demand for transportation equipment and economic uncertainty. While this recession didn’t start with a capital spending slump, the weakness in investment spending could take a long time to dissipate.

The health-related shutdown and reopening of manufacturing, both in the U.S. and overseas, could also accentuate the slump and the bump in the forecast, with inventories falling very sharply in the second quarter and then bouncing higher in the third.

Government spending looks like it will be weak throughout the next two years. The CAREs Act included $150 billion for state and local governments, though earmarked for spending incurred due to the COVID-19 emergency. However, even if this money were used to fill general budget shortfalls, it would still fall woefully short of their needs. In the recession of 2007-2009, which was less than half as deep as the current one, state and local government revenues, excluding federal grants, fell by 6.8%. A proportionate decline in revenues this time around, combined with higher social spending, would leave state and local governments hundreds of billions of dollars in deficit, requiring massive layoffs. Even if state and local governments receive some further help from additional federal relief, it is unlikely to prevent massive cutbacks and layoffs throughout the rest of 2020 and 2021.

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