W for wrong

But not everyone subscribes to this framework of thought. Anirvan Banerji, director of research at the Economic Cycle Research Institute in New York, tells Mint why the alphabet approach to recession analysis is the wrong one, and how he prefers to classify recessions.

Inherently, what is the main problem with classifying recoveries into alphabet shapes? What sort of complexities does it elide over?

Quite simply, if you actually look at the broad measures of aggregate economic activity that define recessions and recoveries, they don’t look like those letters—at best they would be Procrustean fits. For example, the Great Depression of 1929-33 saw economic activity slide steeply in 1929-30, pause for a few months from late 1930 to early 1931, and then slide steeply again until early 1933 before rebounding almost vertically for a few months, and then at a slower but still rapid pace.

Also See | The Recession Alphabet (Graphics)

The deep 1973-75 recession saw only a mild decline in economic activity for almost the first year of recession, but was then followed by a plunge and a sharp rebound. The 2001 recession saw a very mild decline in economic activity, then a mild rebound from late 2001 to mid-2002, followed by a flat period until mid-2003, and then a more rapid rebound. I can keep going, but given the choice among L, U, V and W, what letters would you choose to assign to those episodes? I know this alphabetical shorthand is designed to appeal to journalists, but it’s just silly.

Is there an alternative classification of recoveries that you prefer?

A simple classification of US recessions in the past 50 years would group them into mild recessions (as in 1960-61, 1969-70, 1980, 1990-91 and 2001) and severe recessions (as in 1973-75, 1981-82 and 2007-09). If you go back to the beginning of the 20th century, you could add three depressions (in 1907-08, 1920-21 and 1937-38) and the Great Depression (1929-33). The criteria for classification are the three Ds—depth, duration and diffusion.

Once you get into the 19th century, hard data on the three Ds are more difficult to find, but the five-and-a-half-year 1873-79 depression, following the Gilded Age of excess and extravagance that Mark Twain wrote about, was surely very severe; also devastating to the then-agrarian economy was the six-year depression of 1815-21, triggered by the 1815 eruption of Mount Tambora in Indonesia (the largest in recorded history), which spread volcanic ash particles around the globe, resulting in the "year without a summer" in 1816, along with widespread famine.

Specifically in 2010, as far as the global economy is concerned, what is the pace or structure of recovery that you see, based on trends over the past few months?

The first point to note is that economists do precisely what you suggest, which is to forecast the next few months based on trends from the past few months. This works as long as the economy is proceeding in the same direction, but it is guaranteed to fail at turning points (beginnings of recessions and recoveries), because the trend itself reverses at these times. No wonder that the International Monetary Fund found, based on a 63-country study of economists’ accuracy in recession forecasting, that their “record of failure is virtually unblemished".

Not being an economist or an analyst, but a student of the business cycle, I prefer to look at good leading indexes, which correctly predicted back in April (when the talk at the London Group of Twenty meeting was of the D-word—depression) that the US recession would end this summer. Those objective forward-looking economic indicators are still pointing to a global recovery that will continue to strengthen at least through mid-2010. Because leading indicators cannot see reliably beyond that time frame, there is no good basis for predicting what will happen much beyond that, say, a year from now.

Graphic by Rahul Awasthi/Mint

samanth.s@livemint.com