The U.S. economic recession turned into a free fall in the final quarter of 2008 and the first quarter of this year. Furthermore, the recession recently became truly global in scope and nature as trade flows collapsed around the world and flows of financial capital faltered badly.

It’s easy to imagine a bottomless black hole when the U.S. and global economies go into a contraction phase that’s worse than anything since the Great Depression. But the economy has better recuperative powers than it did in the 1930s; U.S. policy structures are stronger and more responsive, and the extreme seriousness of the situation has prompted an unprecedented degree of international policy coordination. So we’re not locked in a death spiral, and the period of economic free fall most likely is behind us.

Policy Stimulus

It’s impossible to overstate the importance of the multifaceted policy blitz enacted in 2008 and 2009 to counter the deepening recession and the breakdowns in financial systems. It’s fair to say that the policy blitz is saving the U.S. and global economies from truly disastrous circumstances.

The Obama administration’s American Recovery and Reinvestment Act should provide substantial support to the economy over the balance of this year and in 2010. The other two legs of Obama’s policy stool, the Financial Stability Plan and the Homeowner Affordability and Stability Plan, are critical complements to the fiscal stimulus bill.

The Federal Reserve has pulled out the stops as the economic and financial market crisis has broadened and deepened. The Fed recently pushed traditional monetary policy to its limit and has invoked emergency powers to deploy unconventional balance sheet policies to bolster faltering credit markets—including the home mortgage market.

The Fed also is partnering with the Treasury and the FDIC to jump-start various asset-backed securities markets and to implement portions of the Treasury’s new Public-Private Investment Program, which is designed to get troubled legacy assets off the balance sheets of financial institutions.

Green Shoots

Fed chairman Ben Bernanke recently ­talked about “green shoots” that presage economic stabilization and recovery. ­Tender shoots have begun to appear in some sectors and in financial markets.

Perhaps most important, consumer spending has stopped declining following a sharp downshift. A strong surge in business inventory liquidation also appears to be running its course. With respect to housing, sales activity apparently is stabilizing as price and interest rate reductions drive affordability upward and the new first-time home buyer tax credit gains traction.

In financial markets, the forward-­looking stock market has regained some ground; interbank loan markets have thawed considerably; and LIBOR rates have fallen from stratospheric levels. The Fed’s unconventional balance sheet policies have improved credit conditions in markets for home mortgages, consumer loans, and ­business loans; and quality spreads have ­narrowed to some degree in bond markets.

False Spring?

There’s certainly a significant risk that the tender green shoots will burn out rather than blossom into recovery. The job market, which typically is a lagging indicator (not a source of green shoots), could deteriorate more than expected in coming months and cause consumers to hunker down again. Or the new Treasury plan to recapitalize banks and round up legacy assets could fail to gain traction. Consumers and home builders may find it even more difficult to obtain mortgage credit to buy or production credit to build additional homes.

Despite the downside risks, the odds favor the NAHB’s baseline economic forecast, which shows fading of weakness in the second quarter followed by sub-par growth in the second half of 2009, a gathering ­recovery in 2010, and a solid low-inflation expansion for several years into the future.