- Economists have a multitude of ways to describe recessions...
- But are any of them really helpful?
Trying to describe the severity of an economic slowdown is a tricky business – even for policymakers. Last week, Bank of England governor Andrew Bailey argued that the UK economy was facing a “long but shallow” recession, while Federal Reserve chair Jerome Powell thinks the US could still enjoy a “soft landing”. When it comes to describing the shape of recessions, we have a smorgasbord of options. But are any of these terms really helpful?
At the less creative end of the spectrum, economists like to talk about the ‘depth’ of recessions. This is calculated by measuring the drop in GDP from the peak of activity before the recession starts to the trough it reaches before recovery begins. The 1990s recession was relatively shallow, seeing a peak-to-trough decline in GDP of just 2.9 per cent. The pandemic-induced contraction in 2020 was far deeper, triggering a peak-to-trough drop of over 20 per cent.
But the length of a recession also matters. As well as being shallow, the 1990s recession was also relatively brief: the economy returned to growth after 14 quarters. After the 2008 recession, the economy took far longer – 21 quarters – to recover. As the chart shows, the Bank of England (BoE) expects the upcoming downturn to be another prolonged affair: under a pessimistic scenario, the economy could still be 2 per cent below its pre-recession peak 14 quarters after the contraction begins.
And when it comes to describing the eventual recovery, we seem to have half of the alphabet at our disposal. Take debate about the outlook for the euro area: Economists at Berenberg expect a ‘V-shaped’ rebound, thanks to lower energy prices, Chinese demand for exports and supportive fiscal policy. Yet Davide Oneglia, director of European and global macro at TS Lombard, is less optimistic. He thinks that Europe will face a protracted ‘L-shaped’ recovery, thanks to a weak global economy and high interest rates. If BoE projections are right, the UK could be facing something closer to a ‘U-shaped’ rebound.
Things get even more creative when it comes to describing the wider macroeconomic context of the downturn. In the US, there are hopes that a recession could be ‘jobful’ if the economy cools enough to reduce vacancies and wage growth without unemployment rising. Liz Ann Sonders, chief investment strategist at Charles Schwab, also raised the prospect of ‘rolling recession’ over the year ahead. This would see sectors of the economy enter recession one by one, instead of a simultaneous slump.
Then there are ‘hard’ and ‘soft landings – which sometimes even come with debates about the narrowness of the economic ‘runway’ ahead. Unsurprisingly, these terms are borrowed from aviation. A ‘hard landing’ doesn’t necessarily mean a recession, but it does describe a sharp shock for an economy – and probably a bruising one at that. A ‘soft landing’ is a more pleasant experience – a gradual and relatively painless slowdown. Analysts at Goldman Sachs maintain that a US recession is not a foregone conclusion – there is a chance that retreating wage pressures plus the end of the tightening cycle could see the economy enjoy a soft landing instead.
But are these terms just different ways of saying the same thing? A softish landing, a mild recession and a U-shaped recovery would probably all feel pretty similar. And new research from Deutsche Bank suggests that markets don’t care too much about the shape of a recession either. They find that in the US, at least, “the depth of recessions are not massively correlated to the scale of S&P 500 declines”:
The problem is that as a recession starts, no one really knows how bad it will be. As Deutsche Bank’s Jim Reid, notes, “at the time they often feel bad regardless of what the final drawdown is... That makes asset markets nervous in real-time with sharp declines”. He notes that the 1970 and 2001 recessions were mild, but proved “very bad” for stocks.
In times of uncertainty, we are understandably keen to try to clarify what lies ahead. But for markets, whether L-shaped, rolling or shallow, a recession will be unwelcome news. Reid concludes “even if we get a mild one it can still be bad for markets if no one knows at the time it's going to be mild”.
