Economic Recovery Looks Likely, But In What Form?

If the economy were a patient, doctors would say its condition is stabilizing but would caution that it isn't out of the woods just yet.

The latest Commerce Department GDP data released Friday show that while the U.S. economy contracted for a record fourth straight quarter, it shrank at a rate of just 1 percent from April to June. That beats expectations of a 1.5 percent drop and follows a whopping 6.4 percent drop in the first three months of the year.

Most economists now agree that the recession is bottoming out, and they expect a turnaround in the second half of the year. The continuing crisis in the financial sector and banks' exposure to bad debt, however, could still stall a recovery.

The latest numbers could point to a pronounced "V-shaped" type of rebound rather than the less-desirable, drawn-out "U," says Alan Levenson, chief economist at T. Rowe Price in Baltimore. No recovery at all would look like an "L."

"Once we cross zero [growth], it's going to flatten out a bit and still be upward sloping," he says. "It's not going to be stagnation, but I think the hangover of the financial crisis and the continuing need to rebuild the financial sector is going to restrain growth."

Levenson says he expects a gradual recovery, with perhaps a 1 percent increase in the third quarter of this year and maybe 1.5 percent in the last quarter. "This has been a deep recession, and history suggests that after deep recessions, we get strong recoveries," he says.

Brian Wesbury, the chief economist at Chicago-based First Trust Advisors, is more optimistic that a recovery will be the classic, sharp bounce-back from a deep recession.

"We're going to see an increase in the third quarter probably closer to 3 percent to 3.5 percent than the 1 percent to 1.5 percent that is conventional wisdom," Wesbury says.

Consumer spending, which accounts for two-thirds of all U.S. economic activity, has been battered by job losses, falling home values, mounting credit card debt and just plain fear of the future. Although consumer spending was still down in the second quarter after popping up briefly during the first quarter, Wesbury predicts a resurgence as consumer confidence strengthens.

"This kind of panic low can't last. And my view is that when you see the recovery take place, that panic will subside and, in fact, things will come back to more normal levels," he says.

Wesbury believes the government's "cash for clunkers" program, which offers rebates of up to $4,500 for people who trade in their old cars for new, more fuel-efficient vehicles, will help boost spending, even though the program has, at least temporarily, run out of money. Legislation proposed Friday in the House would extend $2 billion in new funding.

But he's cautious about the impact that the Obama administration's economic stimulus plan has had so far.

"It's hard to get great numbers on how much of the stimulus was out there [in the second quarter], but the numbers that I look at show that it was somewhere between $75 billion and $100 billion," Wesbury says. "That can have an impact, but in the grand scheme of things, it's hard to see it in the data today."

Wesbury says the Federal Reserve's impact is far greater. "They have printed an incredible amount of new liquidity" that will eventually be paid for in higher inflation, he says.

The latest GDP numbers, while encouraging, could also prove illusory. Economists have been chastened in recent months by their inability to accurately forecast the twists and turns of the roller-coaster ride that began in December 2007, the official start of the recession.

"I've seen enough things that I didn't expect to see, and I've underestimated the impact of enough things over the past two years that I'm not going to say we're home free and we're on a glide path to growth," Levenson says.

He offers this bit of caution: "The financial crisis is still alive and well, and this is one possibility that could overwhelm the internal tendencies of the economy to recover from recession."

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