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Barrie McKenna

Why the pessimists are worth listening to Add to ...

So the Great Recession is over, right? Maybe not.

We know the National Bureau of Economic Research - the official arbiter of U.S. economic cycles - hasn't issued its formal declaration.

But that isn't unusual. The NBER is typically behind the curve, by choice. It waits until the evidence is clear and incontrovertible - even if that means waiting more than a year after a recession begins or ends to make its formal call.

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Wall Street economists are decidedly less reserved. Most of them buried the recession some time last summer, when gross domestic product turned positive after four consecutive quarterly declines.

U.S. GDP expanded at an annual rate of 2.2 per cent in the third quarter, and likely much faster in the final three months of 2009.

Economists are deeply divided on what lies ahead. Many Wall Street banks are predicting growth of at least 3 per cent in 2010. The U.S. Federal Reserve says growth will be between 2.5 and 3.5 per cent.

The International Monetary Fund, meanwhile, is forecasting a tepid 1.5-per-cent pace.

Farther away from the epicentre of the financial crisis, the doubters aren't convinced the recovery is for real.

"The recession is not over," Michael Intriligator, a professor of economics at the University of California, Los Angeles, told a gathering of economists in Atlanta yesterday. Prof. Intriligator, an MIT-trained economist, predicted the U.S. won't return to pre-recession growth levels for at least another three years. And more worryingly, the job market won't fully recover until 2016.

Prof. Intriligator is part of a small, but vocal, minority that refuses to jump on the recovery bandwagon.

The problem starts with the jobs market. The recession has blown a large hole in the U.S. labour market - 7.2 million jobs lost so far - that could take years to repair.

Economist Heidi Shierholz of the Economic Policy Institute in Washington, D.C., estimates it would take two years of stellar job creation just to get back to pre-recession levels.

Not only must the U.S. restore the 7.2 million "lost" jobs, but it must also create employment for several million more Americans who have joined the labour pool as a result of population growth. She estimated that the U.S. would have to add 581,000 jobs every month for two years - a pace it hasn't matched since the postwar boom of 1950s. The economy shed 11,000 jobs in November. (Data for December are due out Friday.)

Others worry that the nascent recovery will run out of steam when the government cuts off the emergency life support.

Harvard University economics professor Martin Feldstein warned that growth may falter this year because of waning stimulus from federal spending and tax incentives for purchases of homes and autos. "There is a significant risk the economy could run out of steam some time in 2010," said Prof. Feldstein, president emeritus of the NBER.

Another major concern of the pessimists is the state of the lending industry. Former IMF official Simon Johnson, now an economist at MIT's Sloan School of Management, said the U.S. is sowing the seeds of the next crisis by propping up ailing banks and encouraging excessive risk.

By demonstrating to the banks, and to the world, that certain financial institutions are too big to fail, policy makers may actually be making the financial crisis worse.

"The crisis is just beginning," Mr. Johnson said at the Atlanta conference. "Have bankers won? In the short term, absolutely. The immediate opportunity for change has already been missed."

Economist Edward Harrison of Global Macro Advisors has similar concerns. He's worried that policy makers are sending the wrong signals, encouraging excessive debt with unnaturally low interest rates.

Low rates cause businesses and individuals to buy today what they can't afford tomorrow, creating what Mr. Harrison calls a Ponzi economy.

"We still have zero interest rates, massive amounts of liquidity, manipulation of short-term rates, manipulation of long-term rates, and bailouts galore a full 15 months after Lehman Brothers collapsed," Mr. Harrison wrote on Credit-

Writedowns.com. "This is pure insanity."

A retreat into a second, deep phase of recession seems unlikely. But as you survey the economic landscape of 2010, it's worth taking note of what the naysayers are saying.

Follow on Twitter: @barriemckenna

 

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