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Goldman Sachs economists: No double dip (probably)

The economics research team at Goldman Sachs has done excellent work over the past few years; they were among the most prescient forecasters in seeing the economic damage that the housing bust and credit crisis would wreak. So their analysis is worth a particularly close read.

What to make of their latest research note? It is something of a glass half-full, glass half-empty story. Here are excerpts from the report, by Ed McKelvey, issued Thursday. Make your own call on whether to view this take on the U.S. economic outlook as fundamentally optimistic or pessimistic.

"We think a double dip [recession] has a meaningful probability--25 to 30% in our estimation--but it is not in our base case. A big reason for this judgment is that several key components of private-sector activity have already fallen to levels that are quite low relative to historical averages or underlying fundamentals."

"We note the following five sources of protection against a renewed downturn in economic activity--areas where we think the scope for further downside to US real GDP is limited."

"Housing activity . . . Housing starts have fallen to an extremely low level . . . not only by historical standards but in comparison to the rate of household formation . . . Household formation is normally about twice as high as the latest starts rate. Thus, while we do not expect housing to perform its usual role as a cyclical driver of growth, we also see relatively little downside to homebuilding."

"Capital spending, especially on equipment . . . The slowdown in growth could shorten this reinvestment cycle, but it is unlikely that net business investment will turn negative unless the economy tumbles a lot further."

"Autos and other consumer durable goods . . . The low levels to which these outlays have fallen appear to represent a resistance point of sorts."

"Household saving . . . We doubt households will be eager to reduce saving at a time when economic prospects are as uncertain as they appear to be today, but they might see some justification in doing so to replace worn-out durable goods, especially if their outlays for residential investment remain low."

"Employment . . . The fact that companies have so far done little to reverse the steep payroll cuts implemented during the recession suggests to us that they may have some room to absorb disappointments in demand before they resort to renewed layoffs."

Let me try to summarize McKelvey's argument a slightly different way. Activity in each of these areas fell so much during the recession that they just don't have much more room to fall, even if the recovery continues to disappoint. So while sluggish growth may be with us for a while, it's unlikely that there would be a return to actual contraction in economic activity.

-- Neil Irwin

By Neil Irwin  |  August 13, 2010; 10:24 AM ET
Categories:  U.S. Economy  
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Really, all Goldman is saying is that another near term downturn is not a certainty. A 25% probability for a near term downturn is an admission that it is a real possibilty. Given, the standard desire to be as optimistic as possible, a 25% probability of a near term downturn is actually a pretty negative view. But, nobody has any objective methodology for estimating these probabilities. No doubt the patterns Goldman is looking at are realistic ones. Those patterns do point towards at least some kind of sustained slow growth. But the high level of unemployment and the lingering damage from the collapse in housing prices do leave the economy vulnerable to negative surprises. Of course, there is no way of estimating the probability of surprises. But, in the words of Mohamed El-Erian there are many known unknowns and likely to be other unknown unknowns. The probability of a another near term substantial downturn can't really be estimated. But, it likely is at least the 25% that Goldman admits to.

Posted by: Anonymous | August 13, 2010 11:51 AM | Report abuse

So GS thinks that things simply can't get any worse in these five areas and that is why we should be optimistic about the future. From my personal experience I can attest how misleading this logic can be: actually things can get much worse just as you think that it cannot get any worse.

Posted by: TheOne1 | August 13, 2010 5:24 PM | Report abuse

The GS argument that many of the so-called economic indicators are at such a low ebb that further decline is virtually impossible has NO merit.

I recall my(long gone) father, a Wall Street trader, who would have responded "What is low can ALWAYS go lower!"

And guess what?............He was right!

Posted by: BandiniBob | August 13, 2010 7:17 PM | Report abuse

The idea that there is an equilibrium to which the economy will return has been proven false. Any stabilizers are policy stabilizers. People discount too much the effect of the demand stabilizers of unemployment insurance and social security. These and the stimulus have been the only support since the collapse, as it is now apparent that monetary policy and zero interest rates are doing nothing but financing cheap positions on Wall Street.

Keynes and Fisher more than 75 years ago displayed clearly the fallacy of the equilibrium assumption. It has no more validity for being so widely held today.

The low level of the factors identified by Goldman only means they are leading the economy further down.

Posted by: demandside | August 14, 2010 12:25 AM | Report abuse

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