People walk along Broadway as the coronavirus keeps financial markets and businesses mostly closed on May 08, 2020 in New York City.
Spencer Platt | Getty Images
Economists’ latest projections of the shape of the recovery have quickly turned into alphabet soup (V, U, W?), and growing uncertainty about a resurgence of the coronavirus is making the task even more difficult.
A research group with unusual methods it used to predict the current recession has come out with new insights.
New research from State Street Associates and the Massachusetts Institute of Technology indicates that the U.S. economic recovery will most likely be U-shaped. Researchers had warned in January that the economy was vulnerable to a recession – with a 70% chance – even before the pandemic actually hit.
The study looked at the three-year trajectories of two economic indicators – real GDP growth and inflation, and looked at six economic scenarios after a recession – “V recovery”, “shallow V recovery”, “U recovery”, “W recovery”, depression and stagflation.
To calculate the likelihood of each scenario, the researchers used a statistic called the Mahalanobis distance, which is a measurement originally used to analyze human skulls.
“In effect, we ask: given recent economic experience, how unusual would it be for one scenario to prevail in the future versus an alternative scenario?” the researchers said in the journal. “The measurement is powerful and practical because it characterizes in a single number the distance between two multivariate observations.”
The study concluded that a recovery of U has the highest probability, reaching 30.1%. A “U” shaped recovery is one where the economy stays at the bottom of the recession longer on its way to recovery, which typically takes up to two years.
A shallow V-shaped recovery has a 24% chance and a V-shaped recovery has a 21.5% chance. A “V” shaped recovery signifies a strong rally back to a previous economic high, and a shallow V signals a more gradual rebound.
A stagflation scenario, where the economy experiences rising inflation and stagnating economic output, has a 16.1% chance. The AW-shaped recovery, where the economy could experience a second downturn, has a probability of 5.9% and depression is the least likely, with a probability of 2.4%. A depression occurs when the economy experiences a severe and prolonged recession.
V-shape less likely?
Many on Wall Street were hoping for a V-shaped recovery where the rebound is as fast as the crisis, and that’s why the stock market came back so quickly from its March lows. But now, with recent spikes in coronavirus cases and fluctuating economic data, the market is coming to terms with the road to recovery could be long and bumpy.
The National Bureau of Economic Research, which determines recessions, said the United States peaked in February, ending a 128-month expansion, the longest in post-World War II history. .
The economic blow of the coronavirus pandemic has been severe, to say the least. Unemployment jumped to 14.7% and nonfarm payrolls fell by 20.5 million in April, two post-World War II records. The labor market has since rebounded with May’s payrolls report showing an increase of 2.5 million.
US GDP fell 5% in the first quarter and is expected to post the worst decline in its history in the second quarter. The Federal Reserve sees GDP falling 6.5% in 2020 but rebounding to a 5% gain in 2021.
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