Will our recovery be quick or slow and painful? Kohler

Today’s briefing of Reserve Bank directors by the staff should be fairly comfortable, with no shocks, as it was last month. The meeting will end with very little discussion about a change to interest rates, and certainly no vote on it.

We now stand poised at the fulcrum of either the V or the L. If there is to be a sharp recovery, it will start happening between now and Christmas; if we are in for a long stagnation and perhaps a deeper recession, well…it won’t.

This morning another voice was added to the V-shaped recovery camp – Christopher Rupkey, the chief economist of Bank of Tokyo-Mitsubishi UFJ in New York.

Okay, a bit obscure perhaps, and his full research has not been released, so I have to rely on a Wall Street Journal report, but his points are interesting. Rupkey apparently believes the US recession may have ended months ago.

“Consumers and businesses have postponed purchases for six months, the population is still growing about 1.2 per cent per year, and if the unemployment rate is close to peaking, then growth may be firmer than expected in the second half of 2009.”

That’s a big ‘if’ of course, but Rupkey points to weekly claims for unemployment benefits which peaked in the week of March 28 at 674,000. If that peak holds, the recession likely ended in April or May.

The truth is that the economics profession is all at sea at the moment. Things are neither bad enough for the pessimists nor good enough for the optimists.

Part of the reason for this is that this downturn is entirely different to previous ones in one important respect – it was caused by financial market failure, not monetary policy, and governments have acted very powerfully, and very early, to counter it.

There is no precedent for this to help understand what the effect will be – only precedents for governments stuffing things up. In fact, it is still hard to believe they did not muck it up this time.

The Australian Treasury’s Dr Stephen Kennedy spelt out in a recent speech just how unusual the reaction was in Australia last year.

He discussed the first and second stimulus packages, the first home buyers’ grant, the bank deposit guarantee, the aggressive interest cuts, the infrastructure spending focussed on “quick-starting mid-scale” projects, and the jobs compact providing instant training places for all unemployed people under 25.

He concluded that the Government had “put in place policy responses that are slightly ahead of or at least coincident with the downturn in the real economy. This is probably the first time this has happened to this extent in Australian history”.

Writing in the Sydney Morning Herald this morning, Ross Gittins, suggests that behaviour in the labour market is very different this time as well, partly because the initial impact of the “imported blow to activity has fallen hardest on the overpaid financial services industry and mining”, and partly because companies are inclined to “hoard labour” – that is, move to four day weeks and compulsory leave rather than sack workers.

These are important differences. Normally governments and central banks are reluctant to admit that there is a recession, so they fail to act decisively until it’s too late.

Meanwhile companies go into a frenzy of lay-offs because they can see their order books collapsing while the Government is still denying that there is a recession, so they feel unsupported and alone. That’s certainly what happened in 1973, 1982 and 1991.

Last October, Kevin Rudd and Glenn Stevens were, if anything, gloomier, faster, than the business world. The Prime Minister was doing a lot of travelling in the second half of last year and the Reserve Bank governor was constantly talking to his counterparts overseas. As a result they panicked early, and effectively.

And now all central banks are wary of what Janet Yellen, the President of the San Francisco Fed, described in a speech last week as the 1936/7 effect.

She said: “In 1936…following two years of robust recovery, the Fed tightened policy because it was worried about large quantities of excess reserves in the banking system. The result? In 1937, the economy plunged back into a deep recession. Japan too learned that hard lesson in the 1990s, when both monetary and fiscal policies were tightened in the mistaken belief that the economy was rebounding.”

If history repeats exactly, that danger would surface in 2015 (8 years after the crash of 2007), but actually everything is faster and more compressed these days, and could easily happen in 2009 if central banks get carried away.

In fact, the Federal Reserve’s actions during the Great Depression only ever worsened it: monetary policy was tightened in 1928, precipitating the stockmarket crash, rates were raised again in 1931 to protect the currency from a speculative run on it and the banks, and when the Depression was in full swing in 1932 the Fed’s actions were ambivalent and half-hearted (as described by current Fed chairman Ben Bernanke, in a 2004 speech).

Nothing half-hearted about official response to this one – and that’s the big difference.

The impact of that is already evident, and has perhaps been underestimated.

This article first appeared on Business Spectator.