Is the Slowdown in the Recovery Temporary?

Last Updated Jun 15, 2011 8:18 AM EDT

On Tuesday morning, we learned that retail sales fell relative to the previous month, and there have been other signs of weakness in the economy recently. One of the big questions right now is whether the weakness observed in recent data will be temporary, or whether it will persist for some time. To answer this, or attempt to anyway, I thought I'd highlight this analysis by Calculated Risk and then add a few comments of my own:
Key Question: Is the slowdown temporary?, by Calculated Risk: The recent economic data indicated a slowdown in May: only 54,000 payroll jobs were added, auto sales declined significantly, retail sales were sluggish even excluding autos, growth in manufacturing slowed sharply, house prices continued to decline to new post-bubble lows (as of March), and home sales slowed.

This raises a key question: Is the recent economic slowdown temporary or is the U.S. heading into a "double dip" recession?

Some of the recent slowdown was related to the tragic events in Japan that started with the earthquake on March 11th. These events impacted the supply chain, especially for the automakers... Also the sharp increase in oil and gasoline prices - partially attributable to events in the Middle East and North Africa... Oil and gasoline prices have fallen in recent weeks, but are still up sharply from the end of 2010. ... A third possible temporary impact has been the severe weather this year. ...

But are these impacts temporary? The supply chain disruptions are clearly temporary, and the good news is the supply issues are being resolved ahead of schedule. ...

Also the recent decline in oil and gasoline prices will help, although $100 oil is still a drag on the economy. The weather is unpredictable, but hopefully it will be less severe. There are also several other ongoing drags on the economy. These include:
  • Less Federal stimulus spending in 2011. The American Recovery and Reinvestment Act of 2009 (ARRA) is winding down, and will be a drag on GDP growth.
  • The ongoing cuts in state and local spending.
  • The festering financial crisis in Europe. ...
  • The slowdown in China impacting U.S. exports.
  • Another downturn in house prices.
...And of course this is all on top of the generally fragile economy. ... There is still too much excess capacity in most of the economy for a large contribution from new investment (except in equipment and software). We see this excess capacity in housing,... office space, retail space, and other categories of commercial real estate. In addition, household debt, as a percent of income, remains very high and household deleveraging is ongoing.

Of course a sluggish recovery following a financial crisis is not unusual. ...

To answer the key question we need to distinguish between the impact of these short terms issues (supply chain disruption, oil prices, weather), and the ongoing drags. ...

We have to ... remember that Residential Investment (RI) will probably make a positive contribution to the economy this year, for the first time since 2005. ... The positive contribution this year will mostly be due to a pickup in multifamily construction (apartments) and in home improvement. Of course single family housing starts will continue to struggle.

Since RI is the best leading indicator for the economy, I think a pickup in RI suggests the recovery will continue. ... So for now I'll stick with my general forecast for 2011: growth will remain sluggish, but I expect 2011 to be better than 2010 for both employment and GDP growth.
I don't have any big quarrels with this analysis, and it's relatively thorough so there's not much detail to add. I am not expecting a double dip either unless Congress does something harmful such as significant deficit reduction before the economy is ready for it -- and it's not ready now -- or the Fed increases interest rates prematurely.

But although I don't think the economy will turn downward again and plunge into a double dip, I am not expecting a fast recovery either. I expect we'll continue to recover slowly in fits and starts, and that it will be years before labor markets are back to normal. During this vulnerable recovery period the risks are mostly negative. Lots of things could happen to make the picture even worse, an increase in oil prices, problems in Europe that spill over to the U.S., etc., but there is very little on the horizon that might improve our prospects. Monetary and fiscal policy could help, but both are on hold and policymakers are looking for reasons to contract rather than expand. So it's very unlikely that significant help will come from monetary of fiscal authorities.

Thus, I see little reason to expect the recovery to accelerate, but there are reasons to worry that the economy could end up recovering even slower than expected. A double dip, while not expected, is not out of the question.