Georges Gobet/AFP
Georges Gobet/AFP

De-jargoned | Double-dip recession

In a W-shaped growth, the output falls, recovers and falls again.

Euro zone, at the moment, is under threat of suffering a double-dip recession as the economy contracted by 0.2% in the second quarter of 2012 and is expected to shrink by 0.3% in the full year 2012 after expanding by 1.4% in the year 2011. The problem, however, is much deeper at the country level. Greece, for example, is continuously contracting since 2008, but if the entire zone slips into a double-dip recession, it will further hurt the chance of recovery, if any, in the weaker economies. So what is double-dip recession and why are people worried about it?

What is it?

Economists use different letters such as V, U, L and W to describe different types of recession. V-shaped recession is where the output falls and recovers quickly; U shaped recession is when the output recovers with a lag; in L-shaped recession, the output falls and does not recover for a very long time; while when it is W-shaped, the output falls, recovers and falls again. Economists term this last phenomenon a double-dip recession. The financial press in the West terms two quarters of output decline as a recession, which is widely accepted. However, in the US, the Business Cycle Dating Committee of National Bureau of Economic Research (NBER) dates a recession and is not strictly based on the two-quarter output decline, though most recessions in the past fit the criteria. It is important to underline that recession is real decline in output and not a slowdown in growth. So recession and slowdown should not be used interchangeably.

Interestingly, the NBER does not have double-dip recession in its chronology. For NBER, the two periods of output decline is either two different recessions or part of the same recession.

Why are people worried?

A normal recession in the developed world is part of the process of adjustments. For example, when the economy is booming, demand will grow and may lead to high prices. The central bank steps in and raises interest rates. As a result, demand and output comes down and economy, at times, slips into a mild recession. In response, the central bank cuts rates due to which demand and outputs begins to expand.

But things are different in the current context. The developed world, on both sides of the Atlantic, slipped into a recession in 2008 because of a financial crisis. The recovery so far has been very weak, but if Europe or the US slip once again into recession—a double-dip recession—it will be very difficult for these economies to pull themselves out as government budgets are far too stretched to be able to support demand and central banks are possibly reaching the limits of monetary easing.