Is a double-dip recession the least of our fears? Why the economy could be in for a decade of stagnation

Zachary Roth

Amid bleak economic growth and unemployment, the stock market swoon, and the downgrade of the credit rating of the federal government, the fear of a dreaded double-dip recession--or even of a 21st-century Great Depression--has been taking hold.

But a rough consensus among economists may be starting to emerge. According to this line of thinking, although a double-dip is certainly possible, a long period of stagnation--that is, frustratingly low growth--is more likely, much like what we've seen since the recession officially ended two years ago. That would be preferable to another recession, of course. But it would mean that ordinary Americans--especially the roughly 26 million who either can't find a job or have given up looking--can look forward to years of hardship.

"I think extended stagnation, rather than a double-dip, is most likely," Mark Thoma, an economics professor at the University of Oregon, told The Lookout.

An Associated Press survey of economists released Tuesday put the likelihood of a recession--that is, another two or more straight quarters of economic contraction--before August 2012 at only 26 percent. But the respondents also expected the economy to inch along at just 2.1 percent growth for the rest of the year, and to barely do better in 2012.

The Federal Reserve appears to take a similar view. Announcing earlier this month that it would hold interest rates near zero for at least another two years, the central bank said it "now expects a somewhat slower pace of recovery over coming quarters" than it had previously--a prediction that's consistent with a lengthy period of weak growth.

And J.P. Morgan, Goldman Sachs, and Morgan Stanley all cut their growth forecasts last week, with J.P. Morgan predicting just 1 percent growth for the fourth quarter of the year--lower even than the 1.3 percent figure from the second quarter that helped spark double-dip speculation. Morgan Stanley cited in part the federal government's expected spending cuts, which would likely have a negative effect on growth.

Some economists think the focus on the double-dip is counter-productive, because it downplays the damage that a lengthy period of weak growth would do.

"The goal isn't to stay above zero," Jared Bernstein, who recently stepped down as an economic adviser to Vice President Joe Biden, wrote last week. "It's to grow fast enough to put people back to work."

Bernstein argues that instead of focusing narrowly on whether the economy is growing or shrinking, we should look at whether the economy is meeting its potential growth rate, which, based on productivity and the growth of the labor force, is 2.4 percent. By that standard, we've been in what Bernstein calls a "growth recession"--a period when the economy is technically expanding, but not by enough to exceed its potential--since the middle of last year.

According to some scholars, history suggests that's not likely to change any time soon. In a paper written last year for the Kansas City Fed, economists Carmen and Vincent Reinhart found that the impact on the economy and job growth of an economic "shock" like the bursting of the housing bubble and the subsequent financial crisis typically lingers for around a decade. "Income growth tends to slow and unemployment remains elevated for a very long time after a severe shock," they wrote, predicting "a lengthy period of retrenchment."

Even longer-term trends may be in play, too. In his recent e-book, The Great Stagnation, George Mason University economics professor Tyler Cowen argues that developed economies worldwide are in the midst of a slowdown, because the pace of innovation is slowing. For the developed world, large-scale, growth-generating improvements like electricity, penicillin and mass education are all largely completed. The next wave of similar advances--the Internet being the prime example--aren't employing as many people as those that came before.

According to Thoma, the rise in long-term joblessness--already at record levels--that would accompany prolonged stagnation would likely lead to a glut of people dropping out of the labor force entirely, after spending months or years searching fruitlessly for work. Many of these would likely be older workers who decide to simply hang on until Social Security kicks in.

Other workers, especially those in fast-moving industries like technology, would see their skills erode, making it even harder for them to find work, Thoma said. And even those who found work would likely see a reduction in their lifetime earnings, the evidence suggests.

As Thoma summed it up: "The longer the recovery drags on, the more permanent the damage."