The Odds Favor a Mild Recession

03/17/2008 12:00 am EST


David Wyss

Adjunct Professor, Brown University

David Wyss, chief economist of Standard & Poor's, goes through different economic scenarios and concludes that a mild recession is the most likely.

Although the underlying problems of the US economy seem to reflect the 1991 to 1992 recession (which saw gross domestic product, or GDP, fall 1.2% from peak to trough), we think the fiscal stimulus package that President Bush signed and the Federal Reserve's quick moves to lower interest rates will keep this recession closer to the 2001 downturn (when real GDP dipped only 0.4%).

We believe the latest expansion's cyclical peak will be dated November 2007, and the trough is likely to come in July 2008, when the last of the tax rebates are paid out. Thus, the eight-month recession would be shorter than the 50-year average of 10.7 months.

We're forecasting negative GDP growth for the first two quarters of 2008 for a total decline of 0.4%. We expect a 20% drop in the Standard & Poor's 500 index-less than the historical average decline during a recession-to be completed this spring.

The Fed has moved more quickly than we expected, or than it has typically done in the past. It chopped the federal funds rate to 3% from 5.25% in September. We expect another half-point cut this month.

About two-thirds of the fiscal stimulus package, which will transfer more than $160 billion into the economy beginning in May, will take place in fiscal 2008 (ending September). We expect that to bring this fiscal year's federal deficit close to the 2004 record of $413 billion. In terms of consumer spending, the stimulus is likely to be felt primarily in the third quarter.

In our deep recession scenario, real GDP declines 2.2% from its fourth-quarter peak to its first-quarter 2009 trough. The downturn would be about the same length (16 months) as the 1975 and 1982 recessions, but would remain somewhat milder because of the tax rebates. This would still, however, be the third-worst recession in postwar history. The unemployment rate peaks at 7.4% in late 2009, compared with a top of 5.9% in our baseline scenario.
A recession is by no means certain. Lower oil prices and a more rapid calming of financial markets could still avert a downturn. At the same time, a revival of productivity increases could keep inflation under control despite stronger economic growth. The stimulus plan may have a greater impact on both consumer spending and business investment.

[Under this scenario], oil prices drop more sharply than in our baseline, falling to $65 a barrel this summer compared with $75. Unemployment holds near its current 4.9% rate, as real GDP growth is steady. Inflation rates drop because of a stronger dollar and more rapid productivity growth. More robust growth helps control the budget deficit.

This scenario is optimistic, but not unreasonably so. In fact, it's near the expectations we had at this time last year.

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