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Avoiding another recession won't stabilize the economy: San Francisco Fed

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Analysts at the Federal Reserve Bank of San Francisco aren't worried about a double dip recession, although they report the chances of one occurring at 50%. They are concerned that even in an economic environment following four consecutive quarters of increasing GDP, things still may not be stable enough to improve other elements in the economy. Analysts compared the current recovery to others from the past in an Economic Letter released today. The main difference they see between today's recovery and other recoveries is the pace at which conditions are getting better. "While discussions in the media often focus on the likelihood of a 'double dip,' it is important to recognize that, even if the economy avoids another recession, future real GDP growth may not be strong enough to prevent the unemployment rate from rising," the letter stated. "Conventional wisdom holds that severe recessions are typically followed by rapid recoveries. But more than a year after the end of the most severe recession since 1947, the recovery is proceeding at a tepid pace." The San Francisco Fed analyzed business cycles over the past four decades as reported in the Chicago Fed National Activity Index (see below). The index is based on four broad data categories: consumption and housing; employment, unemployment, and hours worked; sales, orders, and inventories; and production and income. As depicted in the chart, the CFNAI recorded extreme negative readings during the recent recession, then bounced back sharply during the second half of 2009. However, in recent months the index shows a stalled rebound. The index recorded three consecutive negative readings for June, July, and August. Compared to other recessions (grey areas), the incline has been vastly less steep, barely reaching above zero into positive growth territory. The San Francisco Fed uses the CFNAI as well as the Philadelphia Fed's ADS Business Conditions Index to predict future GDP growth, which if is at all below potential could send unemployment skyrocketing. For the second half of 2010, the CFNAI model predicts an average growth rate of 1.0%, while the ADS model predicts an average growth rate of 1.9%. The four-quarter-ahead CFNAI model predicts average growth rates through the first half of 2011 of 1.6% and the four-quarter-ahead ADS model predicts 2.2%. The Congressional Budget Office estimates the U.S. economy's potential annual growth rate over the next five years is 2.1%. "Comparing these forecasts with the CBO’s potential growth estimate, a standard macroeconomic model would predict rising or sideways movement in the unemployment rate over the next year," the letter said. "All else equal, a higher estimate for potential growth would imply a more pronounced rise in the unemployment rate for a given below-potential growth forecast." Write to Christine Ricciardi.

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