According to history, the correlation between the severity of downturns and the pace of the subsequent rebounds, suggests that the U.S. economy should enjoy a vigorous rebound this year. However, there are many reasons to rather expect a moderate rebound. Most importantly:

• An extended period of credit restraint has begun following the past decade’s lending and borrowing excesses. The ratio of bank lending to GDP remains far above its long-run trend, and it will be a very long time before there is a return to free-flowing credit.

• The personal savings rate has climbed from its recent lows, but is still below its historical average. With consumers no longer able to tap freely into home equity, the savings rate will be under upward pressure for the next couple of years. The era of rampant debt-fuelled spending has ended.

• The housing sector is not out of the woods yet. There is a massive overhang of vacant properties for rent and for sale, and the rate of foreclosures is still extremely high. • Small businesses remain deeply pessimistic about the outlook with little improvement as yet in their plans for hiring and capital spending. A revival in small business confidence is critical to an improved job market.

• The impact of fiscal stimulus on quarterly growth peaked in Q3 2009. Later this year, policy will likely be a restraining factor.

The above points argue against a vigorous recovery, but do not imply that the economic recovery will abort. Although a swing in inventories accounted for 60% of the 5.7% annualized rise in real GDP in Q4, real final demand is on an improving trend.

Some leading indicators of the labour market hold out the hope that employment growth will soon turn positive, a development that will be critical for the economy to enter a self-sustaining upturn. The pace of job growth in the coming year will not be strong enough to deliver a rapid drop in the employment rate. Nonetheless, consumers will be in a much better frame of mind once employment and thus incomes start to rise.

A final reason to expect a moderate but sustained recovery is the ongoing and broad-based revival in world trade volumes (chart 1). It expanded by a 32% annualized pace in the three months ended November. The growth has been driven largely by the emerging world. This is the new economic reality and there are positive feedback effects to the developed economies. The major economies of Asia and Latin America do not suffer the financial imbalances that are headwinds in the developed world, and growth should stay firm. The IMF’s latest forecasts are for the emerging economies to enjoy real GDP growth of 6% this year and 6.3% in 2011.

We have a cautious view of the economic outlook because of the various headwinds noted above, and the downside risks will linger for some time. Yet, economic cycles follow a process whereby downturns create overshoots and set the scene for recoveries. Inventories get run down too much and production rises as shelves are restocked. Cutbacks in consumption and capital spending create pent-up demand. Barring some unforeseen shock, a double-dip recession would require policymakers to make a major error, not something we are currently expecting.