By Neil Irwin
THE WASHINGTON POST
Tuesday, August 18, 2009

The wounded U.S. economy has shown signs of improvement in recent weeks. But many economists, who were caught off guard by the brutality of the downturn, are accentuating the negative, bracing for head winds that could cause the recovery to be weak.

Huge swaths of the financial system have been damaged, which could lock consumers and businesses out of loans for years to come. American families are saving more and relying less on borrowed money. In this global recession, no part of the world appears poised to lead a buoyant recovery. The government's aggressive stimulus efforts may need to wind down before the economy returns to solid footing.

Typically, a deep downturn is followed by a robust recovery. The 1981-82 recession was followed by explosive growth through the rest of the decade. Many top economists doubt that a boom will follow this time.

"Traditional economic models are built like a rubber band: You pull it hard, and it will snap back," said Martin Neil Baily, an economist at the Brookings Institution. "I find it hard to see where that will come from in this case."

Investors seemed to agree Monday, with major stock indexes falling at least 2 percent on concerns that consumer spending won't rebound anytime soon and that the recent rise in stocks was overly optimistic.

Unlike past recessions, this downturn has its roots in the breakdown of the financial system, triggered by the implosion of massive bubbles in the housing and credit sectors.

It appears increasingly likely that the U.S. economy will grow at a solid pace in the second half of the year, as companies restock depleted inventories. But it is unclear what would come after that, given the ongoing restrictions on credit.

Banks have sustained deep losses, and a wave of soured commercial real estate loans threatens to further limit their ability to lend in the year ahead. A bigger problem looms in credit markets, which account for vast chunks of mortgage lending, consumer loans and commercial real estate loans.

That makes it more expensive for people or businesses to borrow money - if they can get a loan - which could serve as a powerful brake on any recovery.

"Credit fuels housing. It fuels consumer durable goods. It fuels business investment," said Carmen Reinhart, an economist at the University of Maryland. "Credit makes recessions after a financial crisis longer, and all the signs are that is happening this time as well."

A related head wind comes from consumers. Americans are saving more and paying down debt; the savings rate was 1.2 percent of disposable income in early 2008. By the second quarter of this year, that rose to 5.2 percent.

"The household sector has never been so stressed," said RGE Monitor Chairman Nouriel Roubini. "Savings has to go much higher, and that is going to slow growth of consumption even once incomes start growing."

Every dollar that Americans save is one fewer dollar for consumption, which means less economic output.

When the savings rate goes up by a percentage point, spending decreases by more than $100 billion, according to the McKinsey Global Institute.

When nations in financial crisis have defied the trend and experienced a rapid recovery, it was often because of strength elsewhere in the world. But what market today is clamoring for U.S. products?

"Everybody in the world is experiencing the same constraints on credit and on consumption," said Mark Gertler, an economist at New York University.

In the adjustment that appears to be taking place, the U.S. is reshuffling the relative importance of different parts of the economy: reducing consumer spending and investment in housing while increasing exports and business investment.

Exports are down 16 percent in the past year as global trade has plummeted, and business investment is down 20 percent as corporations have become more cautious and as access to credit has diminished.

Although widely held among top economists, the idea that all these head winds will weaken the recovery is not universal. The economy has proved resilient in the past, emerging out of deep downturns with force.

"There is only one reliable regularity in business-cycle history in the United States," said Michael Mussa, a senior fellow at the Peter G. Peterson Institute for International Economics, in a presentation this year. "Deep recessions are followed by steep recoveries, and economic forecasts almost never take account of this regularity."

FULL STORY

SEARCH AUSTIN TEXAS HOMES NOW