When Will the Economy Recover?

We know there was an 18-month recession (an economic contraction) from December 2007 to June 2009. Since then, the economy has been recovering (an economic expansion), both in the U.S. and in the rest of the world. However, because the contraction was so severe and the expansion is so slow, the recovery is far from complete. For example, unemployment remains high, and the real estate market is still depressed.

The question is: how well is the economy expanding? How long will it be until we feel life is back on track?

On September 8, 2011, an important economics group, the OECD (Organisation for Economic Co-operation and Development) issued a thoughtful report that gives us a partial answer to this question.

The OECD is an international organization headquartered in Paris. Their job is to act as an economic think tank for the financial officials of 34 counties including the United States, Canada, Mexico, most of Europe, and Australia. (They do not serve China or Russia.)

In their opinion, the global economy is on track for a full recovery. However, the rate of economic expansion has slowed so much that, if we want to maintain the recovery, we must be extra careful setting our monetary policy.

To be sure, all the national economies do not move in unison. Canada, they predict, will enjoy economic growth significantly better than other countries, in large part because the Canadians have cut their trade deficit significantly.

The European economy, however, will grow much more slowly. Indeed, some European countries will actually experience an economic contraction in the next year. This reflects ongoing debt problems as well as the need for long-term cultural changes.

Compared to Canada and Europe, the United States’ economy is somewhere in the middle: it will enjoy slow growth. That growth, however, must be nurtured and protected.

As part of its report, the OECD issued a two-paragraph summary of the U.S. economy which I have included below. After each paragraph, I have translated the technical terms into plain English. (Note: Like most Europeans, the OECD economists write in British English, not American English.)

OECD Paragraph #1: “Supported by accommodative monetary policy and financial conditions the U.S. economy continues to recover gradually from the recession that ended a year and a half ago. Nevertheless, the adverse effects of the crisis are still being felt, particularly in the form of still-high unemployment. Output growth should gain speed and the unemployment rate should continue to decline through 2012 though the pace of expansion will be limited by household deleveraging and initial steps at fiscal consolidation.”

My translation: “Since the recession ended, the policies of the Federal Reserve and the government have supported economic expansion. However, recovery is slow, and there is still a lot of unemployment.

“Things will get better through 2012. During this time, however, many people will be taking action to correct long-term problems that have still not been completely fixed.

For example, households will continue to lower their debt and companies will continue to downsize to save money. These actions will slow the economic expansion. However, they are necessary for the long-term health of the economy.”

OECD Paragraph #2: “The Federal Reserve should continue to support growth, as the economy lingers below capacity and core inflation remains low, but a modest reduction in monetary stimulus starting in the second half of this year would reduce the likelihood of a potentially destabilising rapid increase in interest rates later. With very large budget deficits and fast-rising federal debt, an agreement on a credible medium-term fiscal consolidation programme will become increasingly urgent as the economy continues to recover.”

My translation: “Like a student who watches TV instead of doing his homework, the economy is not living up to its potential. As such, there is much more room for economic growth than is taking place right now.

“What the Federal Reserve is doing is working, and they should keep doing it. However, their actions, if left unchecked, will create inflation as the economy expands, so they should ease off a bit later this year.

“The main problems are that the U.S. government has deficits that are way too large, and the overall U.S. debt is increasing much too quickly. As such, the government needs a reasonable plan to lower the deficit and cut the debt.”

So, how do we interpret all this? The OECD’s report is both good and bad news.

There is no doubt that the recession has been over for a long time: the economy is expanding. However, as in Europe, the United States has fundamental problems that were ignored until they were exposed by the economic downturn. Fixing these problems is necessary, but it is slowing down the recovery. This is to be expected. In the meantime, we must be patient.

Just as important, the people who set monetary policy must be prudent. This is especially true for the U.S. politicians heading into next year’s presidential election who feel obliged to stake out their positions.

Economics is complicated, and there are no simple solutions. Anyone who tells you different is trying to sell you something.