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Depressing Recession

That this time is different is without a doubt. The question is, how different? While the depth of the contraction may have a parallel with the Great Depression, the speed of the collapse of employment is unrivaled in US history. Thus, the comparison to past economic cycles is fraught with imperfect analogs. The center of the debate is the recovery phase: a sharp rebound that matches the decline? A U-shaped recovery that endures a few quarters before returning to trend? Or the dreaded L-shaped recovery that echoes the Great Depression? Our argument is a bit of each. Some sectors/regions will rebound sharply, some will endure a prolonged contraction, while others will face enduring impairment.

Photo: Edwin Hooper on Unsplash

The economic impact of the Pandemic will most assuredly resemble the Great Depression in depth. The critical question is the length of the recession. Monetary and fiscal policies are unprecedented in their scale and scope. These measures will limit the risk that an economic recession doesn’t become a depression era. The threat still exists. The recessions that occurred, which bookend the 2010s, transpired as the Millennial generation became the dominant proportion of the workforce. These economic setbacks are preventing them from forming new households that would drive an increase in consumer spending for the next decade. A prolonged recession would only augment the effect as they spend less and save more.

Placing the current economic situation in this context enables a better understanding of where the economy goes from here. The first quarter saw a material drop of consumption of $260 billion and investment of $48 billion (exhibit 1). These amounts would annualize into a 6% rate of decline. This quick calculation materially understates the damage. Why? Social distancing was only in place for two weeks during the quarter, and most states didn’t adopt the measures until after the end of the quarter.

Exhibit 1. GDP Contribution by Component

Source: Federal Reserve Economic Database

The States will maintain mitigation measures until at least the end of April. Most States will go further and keep the mitigation measures in place until at least the end of May. The implication is that the economic impact will be a multiple of the previous quarter.

The drop that materialized in the first quarter has not existed in the GDP data from 1947 (exhibit 2). The Great Recession did not approach that peak rate of year-over-year decline, and it was the most significant decline in the data. Neither the stagflation of the Seventies nor the war-induced fiscal expansions of the Fifties or Sixties were as deep as what the economy recently experienced in just two weeks.

Exhibit 2. Real GDP Change (Year/Year, %)

Source: Federal Reserve Economic Database, CRM Calculations.

This outcome leaves a challenge of epic proportions in front of the US economy. A conservative estimate for the second quarter would double the magnitude of the impact from the first quarter. This calculation would result in an estimated decline of $600 billion (12% annualized). The carnage will be much worse than this amount because most States are not lifting their social distancing measures on May 1st. Even for those that are removing restrictions, they are not a complete reversal of prior rules.

The economic output lost in the second quarter will fall north of $1.2 trillion (25% annualized). The decline in the first quarter is k