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Contrary to investor sentiment, the economic outlook has remained largely unchanged. It is expected a depression will be avoided, the financial crisis will continue to ease, America will rally by the second half of 2009, and the rate of growth will be sluggish, as a reflection of a strong inventory cycle and weak final demand. Further, there will be persistently high unemployment for several years yet.

A few months ago depression was a conceivable scenario, but many believe this no longer to be true. The basic reason the depression risk has passed is policymakers - especially in the US and China - acted swiftly in correctly diagnosing the debt deflation risks, and prescribing and implementing monetary and fiscal policies to reduce these risks. The 'Great Recession' will be the longest and deepest of the post-war recessions, but no worse than that.

The financial crisis has started to ease. Initial improvements were in markets benefiting directly from government or central bank support. More recently, there have been substantial improvements in unsupported at-risk markets (investment-grade corporate bonds, high-yield bonds, jumbo mortgages, commercial paper, volatility). Risk spreads are off their peak levels in nearly all markets. This broad pattern provides clear evidence risk aversion is easing. The financial panic has crested and the economy and markets have transitioned into a phase of orderly deleveraging.

The longest and deepest US recession of the post-war era will end mid-2009 as inventory liquidation eases in the aftermath of the shutdown of many domestic auto plants. Inventory liquidations tend to be unstoppable when they are underway but have always proved temporary. It is clear the pace of intense inventory liquidation in the first half of 2009 is unsustainable.

As usual in the early recovery, the large reduction in inventory liquidation should contribute to the transition from declining economic activity to rising economic activity. Already, purchasing manager indices are rising across the world from their cyclical lows. It is expected this pattern will persist, since the inventory liquidation has been excessive, and final demand is beginning to stabilize.

In the US, front-end sectors such as autos and residential construction have reached such depressed levels that some rise is likely from mid-2009 to year-end 2009 and continuing through to 2010. However, late-cycle sectors vulnerable to the large excesses in global and domestic productive capacity, such as private nonresidential construction and capital spending, should remain weak.

There has been a clear historical pattern that the sharpest recessions have been followed by the strongest rebounds. The classic cyclical precedent after such a severe recession would call for an initial growth rate of 6 per cent or more in the early recovery. However, the consensus is that this will not occur in this instance. Instead, a rebound at roughly half that pace is expected.

A powerful V-shaped inventory cycle is anticipated, but the recovery of final demand should be hesitant. Consumer net-worth has been reduced by the reversion of house prices from the bubble highs to levels more consistent with normal house-price-to-income and house-price-to-rent ratios. The drag of a negative wealth effect and gradual deleveraging should persist during the economic expansion.

Some analysts argue the savings rate will continue to shift dramatically higher. Further increases may be more muted than is currently expected. Consumers appetite for saving has risen and this should be encouraged; there could be adverse long-term consequences if they don’t. However, income growth may prove so stangnant that they are unable to achieve their savings objectives.

Interest rates are low and many dividends have been cut or 'passed', creating an income challenge for many, especially those in retirement. In addition, wage inflation is decelerating, creating another challenge for income growth.

The drop in consumer spending in the last two quarters of 2008 was extreme and a gradual transition to expansion from the new depressed level is predicted. The reported savings rate has already increased about 400 basis points from about zero to about 4 per cent. Since debt increases are a form of negative saving, the disruption of consumer and mortgage credit growth has contributed to this rise in the savings rate.

The availability of auto credit and mortgage credit will gradually ease over the next year, permitting a moderate increase in credit growth. Current fiscal policy is using deficit financing to shift income to those consumers with a high propensity to consume all or most of their available income. American consumers do not always do what they should, such as substantially raising their level of savings that comes out of current income. A savings rate close to 5-6 per cent is more likely than the 10 per cent anticipated by some.

There has been some talk that after the benefits of current stimulus wears off, there could be a double-dip recession such as that which occurred in 1981-82. This is unlikely. The context in the early 1980s was that the US Federal Reserve was fighting a multi-decade trend of rising inflation. Credit card controls were imposed in early 1980. The economy contracted, the Fed eased and the economy recovered.

Because inflation remained high and the Fed had not completed its struggle against inflation, the Federal Reserve aggressively tightened monetary policy in 1981 in order to drive the economy back into a disinflationary recession, which did occur.

In contrast, the Fed today has a policy of fighting deflation risks and thus is likely to retain its easy policy for an extended period of time. Since a major premature tightening from the Fed is unlikely, a double dip isn't expected.

In the great debate about deflation risk and inflation risk, the Federal Open Market Committee is on track when it says “the Committee sees some risks that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term”.

The massive global excess supply of labour and productive capacity will contribute to downward pressures on wage inflation and price inflation. The inflationist argument is that rapid money supply growth ensures a major upsurge in inflation. Is this really true? There has been a downtrend in velocity. As financial innovation has gone into reverse with the meltdown of the shadow banking system, strong money supply growth is not yet generating a quick rebound in nominal GDP growth.

Whether today’s monetary growth will generate a major acceleration of inflation in three or four years will depend on the independence and judgment of the central bank in the intervening years in withdrawing liquidity as the financial system normalises. Over the next year or two, however, inflationary pressures should be negligible. In the early phases of demand reflation, productivity growth tends to be quite rapid as the production rebound can be accommodated more by mobilising under utilised resources than by adding productive capacity or new workers. Inflation is almost always low in the early reflation phase of the cycle.

Richard B Hoey is chief economist at BNY Mellon Asset Management