-- John Kemp is a Reuters columnist. The views expressed are his own --
By John Kemp
LONDON, March 3 (Reuters) - Recessions come in many guises -- commentators like to use V-, U-, L- or even W-shaped as a way to describe how manufacturing and business activity can behave during the post-peak contraction and early stages of recovery.
But what does a recession really look like? How far does output typically fall? For how long does output contract? And how quickly does the economy regain the output level at the previous cyclical peak?
In fact, there is no such thing as a "typical" recession. Each recession is sui generis.
In the United States, the current downturn is the 15th recession to occur in the modern era (beginning in 1919, when the Federal Reserve System started to publish estimates of industrial production and manufacturing output).
The attached charts (https://customers.reuters.com/d/graphics/RECESSIONS.pdf) show how manufacturing output behaved during each of these 15 recessions, and how many months it took before output returned to the previous cycle peak. Most recessions spanned more than one year. (To make the charts clearer each recession is named after the year in which it began)
The recessions have been grouped into three categories: pre-war (1920 up to and including the recession caused by the economy's demobilisation in 1945-48); mid-century (during the era of Keynesian macroeconomic management in 1950-1972); and recent (from 1973 to the present day).
While the recessions are chronologically grouped for convenience, recessions in each period tend to resemble one another more closely than those in the other periods.
Pre-war recessions were exceptionally severe (with output typically falling 20-40 percent from peak to trough). But in most cases the recovery was equally swift.
The notable exceptions were the very slow recoveries which followed recessions in 1929 and 1945. The Great Contraction of 1929-1933 and the post-war demobilisation both caused enormous dislocations from which the economy took many years to recover.
Recent recessions have been shallower but recovery has taken longer. Given how little output was lost (compared with the pre-war cycles) recovery has often been a very slow affair.
The best example is the recession which followed the collapse of the millenarian boom in 2001. At the very worst point, output was only 7.1 percent lower than at the previous peak. Contrast that with the 13 percent loss of output in 1926 (the shallowest pre-war recession) or the 22 percent downturn in 1923.
But recovery after 2001 was halting. It took more than 40 months for production to top the previous cyclical peak on a sustained basis. This was far longer than in 1926 (20 months) or 1923 (23 months). Since 1973, short deep downturns have been replaced by longer shallower ones.
The mid-century recessions occupy an intermediate area. They were deeper than recent downturns but nowhere near as wrenching as the pre-war recessions. They were generally slightly longer than pre-war recessions but nowhere near as long as some of the more recent cyclical downturns.
LIQUIDATION AND POLICY
What explains the differences?
Roughly, pre-war cycles were driven by inventory accumulation, misjudged investments and financial manias, and tended to collapse under their own weight. The cycle was largely "autonomous" and driven by its own internal dynamics. Fiscal and monetary policy played little or no role in either ending expansions or promoting recovery.
Once activity stalled and the economy started to contract, businesses aggressively trimmed payrolls, cut output and liquidated excess inventories. Most over-reacted. In a few months, inventories fell below sustainable working levels, and a powerful recovery driven by inventory rebuilding typically began.
In contrast, post-war recessions have generally been deliberately engineered by the U.S. Federal Reserve, as the central bank raised interest rates to stop the build up of inflation. Once the economy slowed and the risk of inflation faded, the central bank has usually reversed course, and cut interest rates aggressively to restart growth.
Deliberate downturns have therefore tended to be much shallower. But the absence of such an aggressive inventory cycle has also tended to ensure that recovery is slower, at least in the early stages.
As is clear from the charts, the current downturn is already deeper than any of the downturns in the 1970s and 1980s. We have to go back as far as the recessions of 1969 and before that 1953 to find a comparable loss of output.
RETURN TO PRE-WAR PATTERN?
The current downturn most closely resembles a pre-war recession. That would be good news (pre-war recessions were sharp but mercifully short) except for one thing: pre-war recessions were driven by an aggressive inventory cycle and did not generally coincide with systemic financial failure.
The only pre-war recession that was accompanied by a similarly widespread crisis in the financial system was the Great Contraction; that lasted for 87 months until the previous cycle peak was recaptured.
Bad though the current recession is (manufacturing output has fallen almost 10 percent from the cycle peak) it is not remotely as bad as 1929. At a similar stage, 13 months into the recession that began in 1929, manufacturing output had fallen 25 percent.
Unfortunately, the current downturn has not reached a cyclical trough. The economy has only really experienced the first round effects of recession (linked to tightened credit and falling business investment and exports). The second round effects from rising unemployment have yet to be felt fully.
Manufacturing output will almost certainly fall significantly more in the next 6-12 months. A further 5 percent loss in manufacturing output (measured relative to the peak) seems reasonable based on recent data from railcar loadings and container shipments.
PROSPECT OF SLOW RECOVERY
It would be unusual if recovery took as long as after the Great Contraction. Policymakers have responded much more aggressively to the crisis. But in one respect the current crisis looks worse than 1929-1933.
The then-nascent Federal Reserve has been much criticised for allowing large swathes of the banking system to collapse in 1930 and then again in 1933, allowing the supply of credit to shrivel.
However, even at the height of the crisis, in 1933, only 8 percent of bank deposits were "suspended". Most banks continued to operate semi-normally, even if credit policy became very conservative.
Moreover, the number of bad loans in the system is generally thought to have been fairly low. Apart from speculative broker loans for buying equities "on margin" and problems in the farm sector, most loans were fundamentally sound, at least until the economy underwent the biggest contraction for 100 years.
During the current crisis, the Fed has been much more aggressive in preventing bank failures (a positive sign) but the volume of imprudent loans has perhaps been much higher than in 1928-1929 (much more negative). Resolving the massive overhang of debt will be the largest drag on the recovery.
The severity of the downturn, and aggressive efforts by manufacturers to cut production and prevent a build up of inventory, strongly suggest the economy is set for a powerful cyclical rebound.
But lingering problems of excess debt point to a much more gradual recovery, as businesses and households focus on paying down debt rather than investment or consumer spending.
Perhaps never before has the path to recovery depended so much on sentiment. If businesses and households can be persuaded to resume at least some investment spending and expenditure on durable items, the low level of inventories in the system would support a very strong cyclical recovery.
But if a more cautious (and let's be honest, more prudent) approach prevails, focused on reducing excess leverage, the recovery will be very muted in its first 18-36 months. The U.S. economy will probably hit a trough in H2 2009, but a strong cyclical upswing is unlikely before H2 2010 or even H1 2011. (Edited by David Evans)