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Friday, July 18, 2008

Krugman on L-ish economic prospects

Paul Krugman explains why he thinks current recession will take longer time to recover, aka L-shaped, than 1990-91 and 2001 recessions.
 

But if the experience of the last 20 years is any guide, the prospect for the economy isn't V-shaped, it's L-ish: rather than springing back, we'll have a prolonged period of flat or at best slowly improving performance.

Let's start with housing.

According to the widely used Case-Shiller index, average U.S. home prices fell 17 percent over the past year. Yet we're in the process of deflating a huge housing bubble, and housing prices probably still have a long way to fall.

Specifically, real home prices, that is, prices adjusted for inflation in the rest of the economy, went up more than 70 percent from 2000 to 2006. Since then they've come way down — but they're still more than 30 percent above the 2000 level.

Should we expect prices to fall all the way back? Well, in the late 1980s, Los Angeles experienced a large localized housing bubble: real home prices rose about 50 percent before the bubble popped. Home prices then proceeded to fall by a quarter, which combined with ongoing inflation brought real housing prices right back to their prebubble level.

And here's the thing: this process took more than five years — L.A. home prices didn't bottom out until the mid-1990s. If the current housing slump runs on the same schedule, we won't be seeing a recovery until 2011 or later.

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