READ at Project Syndicate When Do We Start Calling This “The Greater Depression”?

Dropbox 20140825 Financial Crisis to Great Recession to Lesser Depression to Greater Depression html
Dropbox 20140825 Financial Crisis to Great Recession to Lesser Depression to Greater Depression html

We started by calling it the financial crisis of 2007. Then it became the financial crisis of 2008. Next it was the downturn of 2009-2009. By the middle of 2009 it was clearly the biggest thing since the 1930s, and acquired the name of “The Great Recession”. By the end of 2009 the business cycle trough had been passed, and people breathed a sigh of relief: “The Great Recession” would be its stable name–we would not have to change its name again, and move on to labels containing the D-word.

But we breathed our sigh of relief too soon. Although politicians and their senior aides went on speaking tours playing up “recovery summer”, the United States did not experience a rapid V-shaped recovery carrying it back to the previous growth trend of potential output. In this the post-2009 recovery was lightyears different from the post-1982 recovery. Between the start of 2005 and the end of 2007 U.S. real GDP grew at 3.1%/year. The recession trough in 2009 saw the U.S. real GDP level 11% lower than the 2005-2007 trend. Today it stands 16% below.

Things have been even worse in Europe. The Eurozone experienced not recovery but renewed recession with a second-wave downturn starting in 2010–an event that shifted the consensus name of the current episode to “The Great Recession”. Eurozone real GDP stood 8% below its 1995-2007 trend at the recession trough. It now stands 15% below.

Cumulative output losses relative to the 1995-2007 trends now stand at 78% of a year’s GDP for the United States, and at 60% of a year’s GDP for the Eurozone. These are extraordinary magnitudes of foregone prosperity–prosperity that we were all confident was in our grasp back in 2007: nobody back in 2007 was forecasting anything like what the decade starting in 2008 will turn out to have been like; nobody back in 2007 was forecasting any extraordinary decline in the rate of growth of potential output that statistical and policymaking agencies are now baking into their estimates. These magnitudes made me conclude at the start of 2011 that “The Great Recession” was no longer adequate: it was time to start calling this episode “The Lesser Depression”.

Now, however, we face two additional downward shocks to the North Atlantic economy. Consider the page that Lorcan Roche Kelly of Agenda Research noted Mario Draghi ad-libbing in his late-August Jackson Hole speech:

Inflation has been on a downward path from around 2.5% in the summer of 2012 to 0.4% most recently.

I comment on these movements about once a month in the press conference, and I have given several reasons for this downward path in inflation, saying it is because of food and energy price declines; because after mid-2012 it is mostly exchange rate appreciation that has impacted on price movements; more recently we have had the Russia-Ukraine geopolitical risks, which will also exert a negative impact on the euro area economy; and of course we had the relative price adjustment that had to happen in the stressed countries as well as high unemployment. I have said in principle most of these effects should in the end wash out because most of them are temporary in nature–though not all of them.

But I also said if this period of low inflation were to last for a prolonged period of time, the risk to price stability would increase. Inflation expectations exhibited significant declines at all horizons. The 5-year/5-year swap rate declined by 15 basis points to just below 2%–this is the metric that we usually use for defining medium term inflation. But if we go to shorter- and medium-term horizons, the revisions have been even more significant. The real rates on the short and medium term have gone up, on the long term they haven’t gone up because we are witnessing a decline in long-term nominal rates, not only in the euro area but everywhere really.

The Governing Council will acknowledge these developments and within its mandate will use all the available unconventional instruments needed to ensure price stability safeguard the firm anchoring of inflation expectations over the medium to long term.

In the Eurozone, the pretense that recovery was in train is now gone, and there is no way to read the financial markets other than as anticipating a Eurozone triple dip recession. In the United States, the Federal Reserve under Janet Yellen has moved from wondering whether it will ever be appropriate to cease asset purchases and raise interest rates without a significant upturn in the employment share to ceasing asset purchases and wondering when it will raise interest rates–even without either a significant upturn in the employment share or a significant upward breakout in inflation.

A year and a half ago, when some of us were expecting a return to whatever the path of potential output was by 2017, our guess was that the Great Recession would wind up costing the North Atlantic in lost production about 80% of one year’s output–call it $13 trillion. Today a five-year return to whatever the new normal might be looks optimistic–and even that scenario carries us to $20 trillion. And a pessimistic scenario of five years that have been like 2012-2014 plus then five years of recovery would get us to a total lost-wealth cost of $35 trillion.

At some point we will have to stop calling this thing “The Great Recession” and start calling it “The Greater Depression”. When?

Appendix: Data and Calculations: |

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