Confusion rules in recovery puzzle

(breakingviews.com) -- Shares are having a choppy week. Most of the leading indices are down 2-3% from their recent peaks. But it's too early to say whether the markets have merely paused briefly or reached the end of their long run. Stocks in Europe and the U.S. are up by 35-50% since March.

One thing is clear. A collection of revolutionary fiscal, monetary and corporate policy experiments has helped stop the GDP freefall which started last September. This favorable change in economic direction -- and the cash created by these policies -- explains the stock market rally.

But looking forward, confusion reigns. To take one example, credit is still getting tighter in the U.S., according to the Federal Reserve's survey of loan officers. But the U.S. Treasury reports loans advanced by the 22 banks receiving government aid are up 13% in a month. There are similarly mixed signals in most countries about inventories, unemployment, production and even prices.

Economists would like to help clarify matters, but they are largely at a loss. Neither theory nor history can provide much guidance. The crisis showed the detailed models used by all economists were inadequate in exactly the point of greatest current uncertainty -- how changes in financial conditions affect economic activity. Incredible, but true.

What's more, the models assume the existence of a simple economic pattern: a succession of fairly similar cyclical distortions around fairly stable underlying GDP growth rates. But the credit bubble and crunch may not fit into the schema.

Some economists prefer to throw out the detailed workings of inputs and outputs in favor of relying on what happened in similar situations in the past. But no one knows which, if any, past episodes are relevant.

There have been many recessions and many debt crises in many countries, but this time -- near-zero interest rates, near-record peacetime government deficits and unprecedented government support for the financial system -- really could be different.

Of course, the future will come whether or not it is accurately predicted. But investors and experts have good reasons to keep changing their minds. There could be some more big market reversals before the trends are clear.