Good Read

This from Ryan Avent is worth posting in its entirety.

So, the economic news today hasn’t been all that great — retail sales were off a bit in April, foreclosures filings were at a record in April for a second straight month, and Chinese industrial production and export figures disappointed. This has led every clever pundit to say something clever like “the green shoots are turning brown,” or “the green shoots are withering,” etc. This has annoyed me.

It occurs to me that the problem may be in the vagueness of the phrase “green shoots” — that we’re all thinking about different things. Picture the path of economic output as a sine wave tilted slightly upward, after each peak, the path begins to decline. Initially, it is declining at an increasing rate. Then an inflection point is hit and it begins declining at a decreasing rate. Eventually, the rate of decline hits zero, a trough is reached, and output begins to increase but remains well below the level of the previous peak. Finally, output surpasses the long run trendline and begins heading toward yet another peak. So what part of this curve is green shootish?

For some people, only a return to previous output levels will count as green shoots. For others, only an end to actual contraction — where the rate of decline hits zero — is a marker of the greening of various shoots. Still others might herald the inflection point at which contraction slows as green, a harbinger of better times to come. When I speak about green shoots in the economy, I’m using this last interpretation. This is quickly dismissed by pessimists who say things like, “Things are just getting worse more slowly!” Quite so. That is exactly how one moves from things getting worse more quickly to things getting better. And I think it’s quite difficult to argue that we have not hit and passed the inflection point. The economy being a big, complex, unwieldy thing, we shouldn’t expect every datapoint to describe a perfect curve; we’re going to have good months and bad months in the data all the way through the recovery. But the trends in the data seem clear — a bottom is approaching.

Now others have voiced different complaints vis-a-vis green shoots, namely, that they’ll be rather stumpy for a long time to come. This is an argument over the shape of recession: V-shaped (a recovery as steep as the decline), U-shaped (a bit more laggardly), or L-shaped (very weak growth and a stubbornly high unemployment rate). I have some thoughts about this that I’ll get to later, but insofar as the green shoot debate concerns whether a bottom is near or not, the shape of the upslope is irrelevant.

And we ought to expect that the end of contraction is near. Megan makes some points about the Great Depression here, writing:

"I don’t want to push the Great Depression analogy too far, but what’s surprising when you go back to primary sources from 1930 is the optimism. I don’t mean to imply that everyone thinks things are just swell. But while you know that they are facing the worst economic decade of the twentieth century, they don’t. They’re expecting something more like the recession that followed World War I. People are cutting back, but they’re still spending, particularly because companies are slashing prices to move inventory. It was the long grind of the years that followed, and the catastrophe of the second banking crisis, that scarred them permanently. And this shows up in the economics stats and the stock market, which did not, as we like to imagine, simply decline in a straight line."

Two important things to note. First, we give the Depression the modifier “great” because it was so remarkably unusual in its depth and length. Second, policymakers worked extremely hard to make the Depression long and deep. The lesson there, to me, is that only very rarely do economies contract longer and deeper than the current downturn, and when they do it is generally because policymakers are actively pursuing pro-cyclical policies. Otherwise, they pull themselves out of their nosedives long before they get into Depression-like levels of output and unemployment.

So when Matt says:

"I will say that I think the greatest objective economic risk at this point is policymaker over-optimism. We need the European Central bank to continue loosening monetary policy, and it wouldn’t hurt if some of the world’s lesser central banks followed suit. We could use more stimulus in the United States and elsewhere in the developed world. We need corporate executives to understand the main risk to their interests to be coming from a lack of adequate economic recovery efforts rather than from losing small-bore political arguments with congressional Democrats. We need smart growth policy in terms of tax reform and trade. We need, in short, policymakers to continue to be worried. If they’re worried, and if they act on those worries, then more likely than not things won’t stay too bad for too long. But if they feel confident, then we might really be in trouble."

I say that an outright reversal of countercyclical policies — monetary tightening and deficit slashing — would kick us back into an accelerating downturn situation, but merely holding steady will at most delay a bottom for a few months and flatten the recovery. And even if policymakers hold steady, policy will continue to improve. As financial markets relax — and credit indicators do continue to improve — loose monetary policy will increase in potency. And of course, fiscal stimulus has only begun to trickle out (and simply by dint of the broader downturn, the federal deficit is growing, which is stimulative).

Caveats apply — some new shoe could drop or Congress could lose its mind and enact a spending freeze. But I don’t really see how people can avoid concluding that the worst declines are behind us.

http://www.ryanavent.com/blog/?p=2039