FEWER RECESSIONS BUT WEAKER RECOVERIES
In recent decades, the U.S. economy has become more stable. Notwithstanding the global financial crisis, recessions are milder and less frequent, while recoveries are weaker. The business cycle has certainly not been eliminated, but perhaps it has been tamed.
Several factors explain this increased economic stability, including better inventory management and diminished volatility in the housing sector, government spending and the services sector. In addition, some of the ultimate causes of recessions – the deeper imbalances that build up over time – have faded in their relevance.
What does this mean for future recessions? We use a simple model to consider the question. Data between 1948 and 1998 suggest the probability of recession is around 4% per quarter; however, data over the past 20 years suggest a lower probability. Our model suggests that there is a 50% chance that, ignoring late-cycle dynamics, the current U.S. expansion would survive for another 17 quarters.
The same model tells us that downturns will be less deep. Between 1948 and 2018, the average recession included a 1.9% decline in real GDP. In a hypothetical future recession the decline could be just 1.4%. At the same time, recoveries will be less robust. On average, in the three years following the 11 recessions since 1948, the economy grew by 13.9%. However, based on the last 20 years of GDP volatility, a hypothetical future recovery could involve just 7.0% growth in the first three years.
As the U.S. economy has become more stable, we have seen an evolution in the nature of systemic risk to expansion. Runaway inflation, for example, seems less likely in the future, reducing the risk of rapidly tightening monetary policy. The role of credit has also changed, with easier access to credit smoothing consumption but perhaps also fueling bubbles.
Our analysis focuses chiefly on the U.S., in part because U.S. recessions have often sparked downturns overseas, but also because trends highlighted in the U.S. appear to be relevant elsewhere. However, examining the mean and variance of other economies, including Japan, the UK and a group of 15 European countries, in all cases GDP volatility has diminished and growth has slowed, resulting in more stable global growth. Looking ahead, we expect this trend to continue.
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