What can we learn from past recession-recovery cycles?

Not much, unfortunately. This post began as an attempt to replicate a recent Macroeconomic Advisers (MA) research note that assessed the potential for a strong US recovery based on Milton Friedman’s plucking model. In brief, Friedman hypothesized that the economy was like a string attached to the underside of a upward slanted wooden board, with the board acting as a limit on the rate of growth. In a recession, the string is pulled (or plucked, hence the name) downward creating a gap between actual and potential growth. When the string is released, it will bounce back at a speed proportionate to how far downward it was pulled with the implication that growth in a recovery following a deep recession will be faster than growth following a mild recession.

One problem with trying to replicate the MA study is the low occurrence of recessions in Canada compared with the United States. As the figure shows, Canada had two very deep and prolonged recessions from 1961 to 2007 and a third that began in 2008 (the broken line represents my forecast to 2010).

To test the plucking theory with Canadian data I have plotted the magnitude of Canadian recoveries in the first 4 quarters after a business cycle trough against the depth of the recession. The plot reveals no consistent pattern for economic recoveries in Canada. Indeed, leaving out the blue square representing my forecast, it would be difficult to draw a meaningful regression line though the points below.

The 1981-1982 recession fits Friedman’s plucking theory – a deep recession followed by a robust recovery. However, the 1990-1991 recession was followed by a tepid recovery while healthy recoveries followed the relatively mild recessions of 1974-1975 and 1980. Though in the latter case the recovery was quickly snuffed out by the onset of the 1981-1982 recession.

It is often said that no two recessions are alike and from the above it would seem that sentiment would apply to recoveries as well. I do find it interesting that, in contrast to the results based on US data, the depth of Canadian recession provides little insight into the magnitude of the eventual recovery. Anyone have a theory why this might be the case?

This is bad news

Kevin Page of the PBO has joined David Wolf in forecasting a historic contraction in Q1:

"Mr. Page told the House of Commons finance committee that, based on private-sector forecasts and his own assessments, he expected GDP to contract by about 8.5% in the first quarter of 2009 and by 3.5% in the second quarter." - Globe and Mail

I've only recently begun trying to forecast GDP and in the model that I'm using, it would be very difficult to generate a contraction of that magnitude. I would love to see the details or the rational for the PBO and Merrill forecasts .