A big part of the current economic debate is about the shape of our economic recovery. You know, the recovery, the one which looks to be under way, any time soon.

A V shaped recovery is seen as an outside chance; a saucer shaped recovery has also been mentioned.

ANZ National Bank’s Cameron Bagrie talks of a bathtub shaped recovery, with the economy bumping along the bottom of the bathtub for a while yet. Presumably with the business sector stuck down the tap end, with a leaky cold faucet dripping down the back.

AMP Capital’s head of investment strategy Jason Wong last Friday talked of a “W” shaped recovery: an upturn, followed by a bit of a downturn again, and then up again. Wong is cautiously optimistic – he does suggest it will be a “shallow” W.

Here’s a less optimistic outlook: brace yourselves for a square root shaped recovery, one that will look something like the square root symbol on your calculator.

Why?

Firstly, it does look as though a substantial up-tick is under way. Business mood surveys, both the monthly National Bank survey and the New Zealand Institute of Economic Research’s quarterly survey of business opinion, show optimism might not have made a complete comeback, but pessimism is on the retreat.

Recent domestic indicators – housing and retail – also show a turnaround after the lows of late 2008.

The property turnaround is probably something of a dead cat bounce. Investors with a bit of cash are picking up some bargains at the bottom of the market. Anecdotally, there is also a lot of under-employed builders buying near-slum properties at the bottom of the market and doing them up.

Migration is also holding up unexpectedly well, partly with New Zealanders returning home. These are not likely to be people who need to borrow excessive amounts.

That’s not going to be enough though.

The part of the economy which earns the dosh – the export sector - remains in the doldrums. Finance Minister Bill English is fond of reminding people the tradable sector has been in recession for five years, and our economy has been sustained by borrowing and by government spending.

He’s right – but the implication of this is that the economy needs to rebalance –and it can only do so if people pay back a fair chunk of their debt and the government reins in its excessive propensity to consume.

There’s plenty of talk about that, from English and economists in the public and private sector, but the rubber has yet to really hit the road on either of those.

English’s first Budget reallocated a lot of spending – rightfully so – but did not cut it. At the bottom of a recession, that was the right approach.

But as the economy turns, government spending will have to be hauled in. Politically, that is going to unleash a hail of dead cats and rotten fruit at ministers. It remains to be seen whether they can deliver on this.

Meanwhile, look at monetary conditions - the nexus of real interest rates and the exchange rate. These are tightening – putting pressure on the part of the economy which will get us out of this mess.

The exchange rate remains stubbornly high – on a trade-weighted index in the mid-60s, above the medium term trend. Textbook economics tells you that should not be happening in a recession, but, well, that’s textbooks for you.

The dollar might yet fall, but expectations that it will do so are fading. Bank of New Zealand head of market economics Stephen Toplis warned this morning that if the dollar hasn’t fallen thus far, and if the economy is on the upturn, it is difficult to see the dollar dropping now.

That is going to hurt exports even more.

The official cash rate remains low, at 2.5%, and Reserve Bank governor Alan Bollard has indicated he does not expect to lift the rate again until the second half of next year.

He may change that outlook this Thursday morning, when he reviews the OCR again.

But – as we all know – banks have stopped cutting their interest rates, to businesses and to households.

Medium term, the upward pressure on bank interest rates remains. With New Zealand banks sourcing a large part of their funds offshore, and with global interest rates on the rise to deal with massive demand from governments’ borrowing around the world, businesses wanting to borrow to expand as the economy turns are going to have to pay more.

That, Toplis says, “will crowd out business investment. This in turn means a lower level of economic activity.”

Then there is the new prudential requirements the Reserve Bank is placing on banks. These will be phased in over the next couple of years, so they will not have an immediate impact. But the thrust of them is New Zealand banks will have to source more of their funds from long-term securities, and more from onshore. It is a welcome shift in policy, and one which should pay off. But it won’t be without pain.

That, too, will push interest rates up. Great if you have cash in the bank, not so great if you’re a business borrowing to expand.