June 12, 2020

News in Charts: Longest US expansion comes to an end

by Fathom Consulting.

This week, the National Bureau of Economic Research announced that the US had officially entered a recession in February 2020. We estimate the trough to be in April 2020, making this recession unusually short and sharp, and expect a similarly drastic ‘V-shaped’ recovery with output returning to 2019 levels sometime in the latter half of next year. Despite spurring the longest expansion since 1854, the recovery from the last recession, was sluggish and unspectacular. As seen in the chart below, real GDP growth fluctuated around 2%, rarely exceeding rates of 3% that were more commonplace before 2007.


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Of course, the Great Recession of 2007 and the COVID-19 recession of 2020 are two different beasts. It is well established in business cycle literature that recessions associated with financial crises are worse than those that are not. To counter it, central banks across the world cut interest rates to record lows, and began an extended period of accommodative monetary policy.

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Yet, as we stated in a note to clients earlier this year, the output loss (relative to a pre-crisis trend) from the Great Recession was twice as large as previous banking crises. This was largely due to poor productivity growth. While there may be numerous reasons for this, such as debt overhang and a lack of investment, Fathom have long argued that it is largely a consequence of interest rates remaining too low for too long. Though necessary initially, in our view ultra-low borrowing costs prolonged the life of weak companies, who were in no position to invest for future growth. The charts below highlight this. There is a positive relationship between company failures and productivity growth, as resources are reallocated from less-productive to more-productive firms. Furthermore, the corporate failure rate moves in line with the policy rate. Lower interest rates mean lower company failures, and therefore lower productivity growth.

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This is not to say that corporate failures are always a good thing. In the current crisis, many otherwise viable small businesses will be feeling the damage from three months of little-to-no demand for their products. For now, governments have backstopped losses through grants and loans, helping to keep potential supply unchanged while demand is artificially suppressed. It is right that they did this. However, it remains to be seen whether a vaccine can be deployed at speed and scale. If our way of living has to change for some time to come, some previously viable businesses, such as nightclubs and theatres, may be unviable in the new normal. At some point, by prolonging their existence without any hope of a brighter future, government help may end up preventing a needed reallocation of capital and workers that risks harming productivity growth. If that is the case, the short and sharp recession could be compounded by a long and slow recovery.

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