Gavyn Davies: Recession over? We just can't tell yet

16 April 2009

We may not be entering another Great Depression, but it's a little early for David Miles to be announcing that the only way is up

Near the bottom of the last recession in the autumn of 1991, the chancellor, Norman Lamont , commented that he could see the "green shoots" of economic recovery. Although this proved to be broadly accurate, since the economy had in fact already experienced its period of sharpest decline by then, the chancellor experienced many months of public derision before the public noticed that the recession was ending. The economist's time lag proved politically fatal for the unfortunate Lamont, and from that point onward public figures vowed to avoid raising false hopes about economic recovery.

David Miles , the newest appointee to the Bank of England's Monetary Policy Committee, broke this rule yesterday, when he suggested that the worst of the UK recession might now be over . He could be right in the sense that GDP growth rates may have hit bottom, though that is not the same thing as saying that the economy has stopped declining, still less that it is now emerging from recession. For unemployment to stabilise, we need GDP to resume a solid growth rate of 2.5% or better. Only then will most people be willing to believe that the recession is over.

UK real GDP fell by 1.6%  in the fourth quarter of 2008, which translates to a quarterly annualised rate of minus 6.1%. One of the key reasons for this precipitous rate of decline was that businesses stopped ordering new purchases to reduce the build-up of unwanted inventories on their shelves. This cannot go on forever, and there is now mounting evidence in the UK and other major economies that the pace of de-stocking is beginning to slacken. This will produce an automatic improvement in the negative growth of the economy, and it may even be enough to ensure that the growth rate of GDP may turn marginally positive in the second half of the year.

Equity markets are already sensing that the freefall in the level of GDP may be nearing an end, which is a major relief, since it was previously possible to worry that the economy was headed into another Great Depression . This worst-case scenario now seems less likely. But any durable recovery worthy of the name requires that the fundamentals of housing, consumer demand and corporate investment start to improve on a permanent basis. It is far from clear that this is yet happening. The shock to confidence experienced in this recession, and the consequent effects on the private sector's willingness to spend, are unlikely to be quickly forgotten. Furthermore, when the economy does start to recover, the government will need to correct its budget deficit by raising taxes and cutting public spending, and the Bank of England will need to reverse its recent injections of extra money supply into the system. This will slow the bounce-back in the economy.

So while the economy may now have passed the point of its sharpest rate of contraction, it could be many quarters before it is safe to claim that the recession is truly over.

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