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German manufacturing orders look strong




Despite the drumbeat of pessimism that seems just about everywhere, good news can still be found. This morning it was news that German manufacturing orders rose by a surprising 2.8% in April, far more than the 0.4% decline that was expected. Over the past 12 months, orders are up fully 30%. As the chart shows, you might say that German manufacturing orders are experiencing a V-shaped recovery.

That brings up a subject I've wanted to address for some time. What exactly constitutes a V-shaped recovery? Could it simply be a chart that looks something like this one? What about the slope of the right side of the V: how steep does it have to be to qualify as V-shaped?

Here's one proposal that makes sense to me. To begin with, just about every economy in the world suffered a recession of sorts that drove actual output below its long-term trend. According to my calculations, for example, U.S. real GDP appears to be about 10% below its long-term trend (or call it full-employment output). The long-term trend growth rate of our economy is roughly 3%. We won't have a full recovery until real GDP returns to trend, and that will require that real growth exceed 3% a year for some period.

So I'm going to propose that a V-shaped recovery is growth that, if it continues, will eventually restore the economy to its full-employment level of output. In the case of the U.S., that would be annual real GDP growth of more than 3%. If growth is only 3%, then we will be permanently below full employment and the unemployment rate will be forever very high, and the mood of the country will be sour, if not worse. That's what I would call an L-shaped recovery--it's not really a recovery at all.

The chart above would be a good illustration of a V-shaped recovery, since if the current trend in German manufacturing continues, then activity will return to its long term trend in a few years.

The key to whether a recovery is V-shaped lies in whether the slope of the right side of the V is greater than the economy's trend rate of growth. If it is, then it's a V. If it's not, then it's an L.

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