Things To Look For In An Economic Tipping Point

Economist Mark Thoma from Economist's View discusses what to look for in an economic tipping point. He describes the specific conditions that will need to occur that will demonstrate that the economy is on solid footing and has the legs to generate self-sustaining growth. However, if these conditions do not occur, we may be looking at a double-dip recession. Continue reading to learn more.
One question I am asked fairly often is how we will know when the economy turns the corner and we are on our way to a solid recovery. My answer is that we will be able to detect upticks in the data, though this may come with a bit of a lag, the important but harder task will be to understand why the data are showing improvement.

In order to be convinced that the economy is on solid footing and headed to better times, I will want to see several things. First, though not necessarily foremost, that banks are being recapitalized with private sector funds, and that this is happening without the aid of government guarantees or other such programs that encourage capital infusions (which is hard to determine while the government programs are in place). Second, I will want to see private sector non-residential investment improving, another sign that private sector funds are moving back into circulation. Presently, this hasn't even started heading back upward, though there are signs the decline is slowing:



And there are other important factors too, e.g. consumption rebounding (though not to pre-crisis debt sustained levels), stabilization in housing markets, and so on. The point is that a self-sustaining recovery will require that the private sector be the primary driver of new economic activity, and that is what I will be looking for.

Once the economy does start to recover, the hard but critical part will be to determine how much of the recovery is self-sustaining (as it will be if private sector funds are driving the activity), and how much is being driven by government stimulus programs. If the recovery is self-sustaining, and we are fairly certain of that, then we can begin to carefully wind down the government programs supporting the economy. But if the recovery is mostly due to government stimulus and there is little sign that the financial and real sectors are attracting robust levels of private sector funds, then pulling back on government programs could be disastrous and plunge the economy right back into recession. In fact, in such a case, we may need to provide even more stimulus to fully bridge the gap until the private sector can support the economy on its own.

So, in answer to the question, we will have a pretty good idea when the economy turns the corner, but it will take awhile to determine why, and we cannot risk pulling back on government programs until we are sufficiently certain that the private sector can support normal economic activity without the government's help.

Update: Nouriel Roubini:

A Phantom Economic Recovery, by Nouriel Roubini, Commentary, Project Syndicate: Where is the US and global economy headed? ... Data from the US ... suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. ...

Moreover, for a number of reasons, growth in the advanced economies is likely to remain ... well below trend for at least a couple of years.

The first reason is...: Households need to deleverage and save more, which will constrain consumption for years.

Second, the financial system ... is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending. Third, the corporate sector faces a glut of capacity... As a result, businesses are not likely to increase capital spending.

Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth. ...

There are ... two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. ...

A second reason ... concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy... The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.

So, the end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anemic rather than robust..., and there is a rising risk of a double-dip recession. ...

This article has been republished from Mark Thoma's blog, Economist's View.