>GREAT RECESSION ENDS; AGE OF UNCERTAINTY BEGINS

The day has finally arrived that we can confidently say the Global Great Recession has ended. There were inklings that this transition was getting underway in the second quarter, when a number of the large emerging economies started to shoot out of the gate – particularly the Asian newly industrialized countries, India, China and Brazil. However, this was not all together surprising given that the financial systems of these countries were largely insulated from the mortgage subprime trap that had snared the banking systems of the advanced economies in Europe and North America. Hence the greater signal that the global recession was ending really materialized when France, Germany and Japan stepped out of the recession shadows in the second quarter and were able to extend growth into the following quarter. The global recovery was finally clinched when the North American economies jumped into the mix in the third quarter. Currently, the only G-7 country still stuck in a recession is the U.K., but that economy looks poised to make its lagged exit in the fourth quarter.

So the world economy is gaining traction and is expected to expand at a rate of 3.8% in 2010. Behind the recovery lies a well-synchronized dance. Financial markets are on the mend, as witnessed by sharp rebounds in global equity markets and declines in credit spreads. Housing markets are in repair, as witnessed by falling inventory levels and rising prices, particularly in the US and UK – the epicenter of the problem. Industrial production is on the rebound, as witnessed by replenished inventory levels and a pick-up in global trade. And lastly, but most importantly, consumers are more engaged, hence spurring the improvements in everything above.

The recovery is underway, but for the advanced economies that were deeply snared in the financial crisis, the recovery is not going to have the typical head of steam of past recoveries. For instance, the above graph demonstrates that the 1957-1958 U.S. recession reflected a contraction of similar magnitude to the 2008-2009 recession, but the pace of recovery then was more than three times stronger in the first year. As a rule of thumb, growth in real economic output during the first year of a recovery for an economy is typically 2-3 times larger than the decline over the course of the recession. But, we don’t believe this will be the case this time, as studies of past banking crises show that output for an economy grows more slowly relative to the pre-crisis trend for a number of years after the recovery has taken hold. There are many reasons why this occurs, including employment suffering enduring losses relative to the trend, credit flow destruction, risk aversion among financial institutions, and deep losses in household wealth. We have incorporated this view in our forecast by lowering the potential GDP growth forecast for the U.S. and Canadian economies to an average of just 2% (about half to a full percentage point below pre-crisis levels).

To read the full report: ECONOMIC FORECAST