Hamish McRae on the shape of the downturn: will it be a U, a V, or even an L?

Short and deep or long and shallow? Now that use of the R-word is officially sanctioned by the Bank of England and the Chancellor we can have a proper debate about the likely profile of the recession. You can think of it innumbers – what the drop peak-to-trough will turn out to be – or in the shorthand of letters: what growth might look like when plotted on a graph: a V, a W, or a U. And if you want to be really pessimistic, add an L.

The Bank's view, set out in the Inflation Report, is that the steep slide into recession that began in the middle of this year will bottom out at the end of March next year, and that by the end of 2009 the economy will be growing strongly again. As you will have seen in the fan-charts printed in this paper and others yesterday, it looks like a V.

Related articles

• Brown borrowing could destroy sterling, Osborne warns
• Housing market 'far worse' than figures suggest
• Eurozone enters recession
• Simon Calder: Sums no longer add up for Britons holidaying on the Continent
• RBS to axe 3,000 staff
• Hands up if you made billions of dollars out of the credit crisis
• Geoff Haynes: Lost your job? Don't despair...
• Adrian Hamilton: Don't count on a new Bretton Woods
• A prize for Mandelson – humiliation for Osborne
• Michael Brown: Cameron must ditch Osborne as Tory shadow chancellor
• Prime Minister calls for global tax cuts to curb recession
• HSBC may be forced to repossess its own home
• BT to cut 10,000 jobs as it gears up for recession
• Germany faces 'dire winter' as falling exports leave it in recession
• Forecast for oil price slashed by IEA
• Barclays faces mass abstentions at EGM
• Emap to join Trinity and Haymarket in job cuts
• Jeremy Warner: Bretton Woods II this is not, but at least it is a start
• Jeremy Warner: Job losses keep on mounting
• Jeremy Warner: Barclays faces protest vote
• The Big Question: Why is General Motors in such trouble, and can it be saved?
• Credit crisis diary: Harbinger of doom
• Pound sinks to record low against the euro
• Search the news archive for more stories

We will get the Treasury version on Monday week with the pre-Budget report, but I would be surprised if it were very different from the Bank's prognosis.

It is hard to work out exactlywhat the peak to trough decline is from the chart, but Simon Ward of New Court has done some calculations and reckons the Bank is going for a 2 per cent fall in total, with an annual growth rate of minus 1.3 per cent in 2009, followed by growth of 1.7 per cent in 2010. If this turns out to be right the decline will be a little less bad than in the early 1990s, when the peak to trough fall was about 2.5 per cent.

That is interesting. From all the guff you read we would seem to be facing the worse recession in living memory, yet these official forecasts seem to be consistent with a slightly less serious dip than the early 1990s one, at least for the UK.

As for the calendar year forecast, the number for 2009 is the same as that of the IMF, which recentlypredicted that we would have a worse recession than any other G7 economy. However it is rather more gloomy than the last numbers from Goldman Sachs, which are worth digging into because Goldman has also just revised its estimates of the shape of the global downturn.

Goldman now has the US at minus 0.8 per cent next year, the UK and eurozone both at minus 0.3 per cent, and China and India at a little under 9 per cent and 6 per cent respectively. These numbers also look broadly similar to the new OECD forecasts out later this month but foreshadowed yesterday.

So I suppose you could say that if the Bank of England turns out to be right we are in for something pretty similar to the early 1990s, though maybe not quite as bad, whereas Goldman is saying that we will have a nasty dip but not as serious as the US and not nearly as serious as the early 1990s.

Goldman has also changed its views about the shape of the global downturn. Instead of it being aU-shaped one, it thinks it will be more of a V. The next chart shows the old forecast, the blue line; the new one, the black line; and theaverage of previous recessions, the red line. The zero in the middle is bottom point of the cycle with years plus and minus on either side. So Goldman thinks that instead of there being a slow decline and then a slow pull-out, this cycle will be much more conventional. We are whizzing down even more sharply than usual, but we will pull out more swiftly, too. The trough will be the first quarter of next year.

I find this really interesting. It is certainly true that the world economy has hit some sort of wall in the past six weeks. It is too early to be able to have any perspective on this, but I expect when all is done and dusted we will blame the financial disruption following the failure to rescue Lehman Brothers as the principal cause.

So we are certainly going down very fast. But the world economy was in trouble before that. Germany, as we have just seen, is now officially in recession, with growth stopping in the second quarter and the economy going down further in the third. The eurozone will almost certainly report the same experience. But the speed of the downturn has been pretty shocking, even to those of us like myself who have maintained ad nauseam that next year will be the one to worry about, not this one.

So as far as the downward leg is concerned, this is certainly a V. It does not inevitably follow that the bounce out will be as sharp as the slide in. There are at least two reasons why it might. The most obvious is the huge monetary and fiscal response by the authorities. Interest rates are being slashed, liquidity is being pumped into the money markets, the banks are being recapitalised, and taxes will be cut around the world.

There will be a price to pay for this, and more about that in a moment. But meanwhile these actions, and those that are to come, must have had some effect by the summer of next year.

The other obvious reason is the continuing demand from the BRICs. Next year all the additional demand in the world will come from the emerging economies. Yup, all of it. Overall growth comes down from 3.5 per cent to a bit over 2 per cent, but it is the emerging world that is pulling its weight, not the developed world. There is surely some sort of moral there.

My biggest concern is the long-term costs of these expansionary policies that are being used to try to pump up growth next year. In the US the rescues are going beyond the banking system (where the UK model now looks like being adopted instead of the US one). In Europe the scale of the banking woes may turn out to be even bigger than in the UK, as the gearing of continental banks was greater. And in the UK the plan to try to borrow our way back into growth will leave taxpayers in 2010 onwards having to service the huge debts that are going to be incurred by this government. It looks as though Labour will hand the Tories an even larger fiscal deficit in 2010, proportionate to GDP, than the Tories handed Labour in 1997.Add in all the off-balance sheetliabilities, and taxpayers will face a huge slog through the next upswing, as most of the growth will have to go to cope with public-sector liabilities rather than increased livingstandards.

It is our problem, but it is also the developed world's problem. There will be a recovery, of course, and it may well be that this will be evident by the end of next year. But it will be a different sort of recovery from the ones we have been used to, a slog rather than a bounce.

And I don't think it will be secure until property prices worldwide have got back to their long-term equilibrium levels, which is certainly further away than next summer.