The mood on the markets has definitively soured. The global economy just can't shake off its troubles. Last week's US labor market report surely didn't lift anyone's spirits, with its message that the business cycle of the world's largest economy remains fragile. Is a depression ahead?
At the least, the double-dip discussion has restarted. Commentators are gauging the prospects of a second recession within twenty-four months, which last happened in the US in the beginning of the 1980s. Some pundits are even conjuring up the specter of a full-fledged depression, talking about having a "1932 feeling." While we do not dispute that the latest economic data was surprisingly weak, we think care should be taken when using a potent word like "depression."
For example, in the three years between 1929 and 1932, the US unemployment rate shot from almost nil to 25%. This surge far outstrips current developments on the US labor market, where unemployment has risen from 4.5% three years ago to roughly 10% today.
There is no hard and fast line distinguishing a depression from a recession. The usual rule of thumb for a recession would be three consecutive quarters of negative GDP growth. A depression is often defined as three consecutive years of shrinking GDP. While this situation might occur in some peripheral European countries, especially those that are implementing tough austerity measures, no one is forecasting such contraction for the US economy.
Another rule-of-thumb definition for a depression is that GDP must fall by more than 10% from its previous peak. Again, some particularly hard-hit peripheral European countries may meet this criterion, but the US cannot be counted among them. At its deepest trough, in the second quarter 2009, US GDP was "only" 3.8% below its peak in the second quarter 2008.
This is the good news. There are also some decidedly less good developments. Consider the widely acknowledged view that, in the 1930s, the US and other countries slid from a steep recession into an abysmal depression because governments failed to act. Despite having the latitude and the means to do so, they stood mutely on the sidelines, employing neither monetary nor fiscal policy to reverse the downward economic spiral.
Over the past couple of years, only massive government intervention has kept the US and some other large, recession-battered economies from tumbling into a depression. This is about to change. Governments now appear far less willing and less able to intervene again. Hence, while the likelihood of a full-blown depression remains, in my view, negligible, the D-word will probably be on pundits' lips for a couple of more quarters.
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