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Wednesday, September 14, 2011

Double-Dip Recession: Previous Experience and Current Prospect

Craig K. Elwell
Specialist in Macroeconomic Policy

Concerns have been expressed that the United States may be about to experience a “double-dip” recession. A double-dip or W-shaped recession occurs when the economy emerges from a recession, has a short period of growth, but then falls back into recession. This prospect raises policy questions about the current level of economic stimulus and whether added stimulus may be needed. The pace of the recovery has been relatively slow and growth has recently decelerated. For the first year of the recovery, real GDP grew at an average rate of 3.3%, slow by the standard of earlier post-war recoveries, but fast enough to stop the rise of the unemployment rate at 10.1% in October 2010 and to cause it to fall to 9.5% by mid-2010. However, in the recovery’s second year, the rate of GDP growth slowed to an average rate of 1.1% and the unemployment rate was only slightly lower at 9.1% in July 2011. Other indicators, such as weak consumer spending, high unemployment, falling house prices, reduced flows of credit, and the prospect of fading fiscal stimulus, are also worrisome.

Double-dip recessions are rare. There are only two modern examples of a double-dip recession for the United States: the recession of 1937-1938 and the recession of 1981-1982. They both had the common attribute of resulting from a change in economic policy. In the first case, recession was an unintended consequence of the policy change; in the second case, recession was an intended consequence.

Historically, there has been what is termed a “snap back” relationship between the severity of the recession and the strength of the subsequent recovery. In other words, a sharp contraction followed by a robust recovery traces out a V-shaped pattern of growth. However, unlike earlier post-war recessions, the recent recession occurred with a financial crisis. Research suggests that a slow recovery with sustained high unemployment is the norm in the aftermath of a deep financial crisis.

The prelude to the economic crisis in the United States was characterized by excessive leverage (the use of debt to support spending) in households and financial institutions, generating an asset price bubble that eventually collapsed and left balance sheets severely damaged. The aftermath is likely to be a period of resetting asset values, deleveraging, and repairing balance sheets. This correction results in higher saving, weakened domestic demand, a slower than normal recovery, and persistent high unemployment, but not necessarily a double-dip recession.

Slower growth in the first half of 2011 was, in part, attributable to temporary factors such as supply chain disruptions caused by the earthquake in Japan, recent floods and tornadoes in the South and Midwest, and the spike in many commodity prices, particularly oil. Nevertheless, recent economic indicators suggest that the recovery’s underlying momentum has also weakened. While not leading to projections of a double-dip recession, this weakening has prompted many economic forecasters to trim their near-term growth projections from those made earlier in 2011.

This report discusses factors suggesting an increased risk of double-dip recession. It discusses other factors that suggest economic recovery will continue. The U.S. historical experience with double-dip recessions is also presented. It examines the role of deleveraging by households and businesses in the aftermath of the recent financial crisis in shaping the likely pace of economic recovery. The report concludes with a look at current economic projections.

Date of Report: August 31, 2011
Number of Pages: 13
Order Number: R41444
Price: $29.95

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