WASHINGTON — As people pay more than ever for everything from bacon to gasoline and the Federal Reserve hikes interest rates in response, some economists say a recession is likely on the horizon, while others say one is already here.
“The war in Ukraine, lockdowns in China, supply-chain disruptions, and the risk of stagflation are hammering growth,” World Bank President David Malpass said in a statement last month. “For many countries, recession will be hard to avoid.”
Financial markets have taken a hit in recent weeks, with stocks in the United States dipping into bear market territory in mid-June amid record-high inflation levels, Russia’s attack on Ukraine, and pandemic-related supply chain problems.
But one typical indicator of a recession, a growing number of people out of work, is so far nowhere to be found. In May, the unemployment rate was 3.6%, similar to pre-pandemic levels, according to the Department of Labor.
The unusual economic situation is largely due to COVID-19, experts say, and the ways in which the pandemic has reshaped the economy, presenting Wall Street and policymakers with a unique challenge to navigate.
“Aside from the pandemic-induced 2020 recession, other recent recessions have been credit-driven, including the Great Financial Crisis of 2007-2008 and the dot-com bust of 2000-2001,” Lisa Shalett, chief investment officer at Morgan Stanley, wrote recently. “In those cases, debt-related excesses built up in housing and internet infrastructure, and it took nearly a decade for the economy to absorb them.”
She added: “By contrast, excess liquidity, not debt, is the most likely catalyst for a recession today. In this case, extreme levels of COVID-related fiscal and monetary stimulus pumped money into households and investment markets, contributing to inflation and driving speculation in financial assets.”
Officially speaking, the U.S. is not yet in a recession. That designation comes from the National Bureau of Economic Research, which describes recessions as involving “a significant decline in economic activity that is spread across the economy and lasts more than a few months” and uses a range of data, including employment figures, to make determinations.
“It’s hard to imagine a significant decline in economic activity without rising unemployment,” Tara Sinclair, an economics professor at George Washington University, told the Washington Examiner by email. “Right now people are seeing the economy as not doing well not because of a decline in economic activity but because they cannot get all the goods and services they want at the prices they used to pay. That’s very different from a recession, but the Fed fighting this inflation may cause a recession. So it doesn’t appear we’re in a recession right now, but we could be heading into one.”
The Fed started increasing interest rates in March after not doing so for several years, and last month, it raised interest rates by three-quarters of a percentage point — the biggest hike since 1994.
The aggressive move followed the release of fresh data from the Labor Department showing that inflation had yet to slow down and had instead continued to rise despite the Fed’s previous actions. The consumer price index, which tracks how much consumers pay for a range of goods and services, jumped 8.6% in the last year, “the largest 12-month increase since the period ending December 1981,” the department said.
“We need to get inflation back down to 2%,” Fed Chairman Jerome Powell told senators in a recent congressional hearing, NPR reported. “We’re using our tools to do that. And the public should believe that we will get inflation back down to 2% over time.”
“We’re not trying to provoke, and don’t think that we will need to provoke, a recession,” Powell said. “But we do think it’s absolutely essential that we restore price stability, really for the benefit of the labor market as much as anything else.”
Rep. Jim Himes (D-CT), who previously worked as a Goldman Sachs banker, recently told Politico there’s “no question that growth will moderate” as the Fed hikes interest rates. “But with unemployment at 3.6%, you’re a long way from the ugly effects of a recession.”
In late June, the International Monetary Fund said the “U.S. economy has staged a strong recovery from the COVID-19 shock” and that the “positive effects of unprecedented policy stimulus, combined with the advantages of a highly flexible economy, have been clear,” pointing to lower unemployment and poverty rates. The IMF predicted that “the U.S. economy will slow in 2022-23 but narrowly avoid a recession.”
Still, inflation poses risks, IMF staff wrote. “The policy priority now must be to expeditiously slow wage and price growth without precipitating a recession,” the group said. “This will be a tricky task. Global supply constraints and domestic labor shortages are likely to persist, and the Russian invasion of Ukraine is creating additional uncertainties.”
Complicating the task, the IMF said, is the fact that this economic scenario is unprecedented in recent history. “The last time that the U.S. had to contend with a material acceleration in inflation was in the 1980s, a period when both the structure of the economy and the framework for monetary policy were markedly different,” the group said. “As a consequence, past episodes may not provide a useful guide in navigating the current conjuncture. This difficult policy endeavor is complicated even further by the uncertain and ongoing structural shifts in labor markets and the broader economy that were catalyzed by COVID-19.”
Though the early months of the pandemic brought an onslaught of layoffs due to sudden lockdowns across the world, the tables have turned more recently, with companies struggling to fill job openings, particularly in the service industry. The labor shortage is due in part to what some have dubbed the “Great Resignation,” a recent trend with various causes that has seen workers quit their jobs, often to take better, higher-paying ones, in record numbers.
Still, the U.S. may already be in a so-called technical recession, defined as two consecutive quarterly drops in GDP, or gross domestic product. GDP decreased by 1.6% in the first quarter of this year, according to federal government data, and one key preliminary Fed estimate shows the economy has further contracted this quarter. GDP is on track to shrink by 2.1% in the second quarter, according to the Atlanta Fed’s GDPNow tracker.
“The model’s long-run track record is excellent,” Nicholas Colas, co-founder of DataTrek Research, wrote in a recent note. “Since the Atlanta Fed first started running the model in 2011, its average error has been just -0.3 points. From 2011 to 2019 (excluding the economic volatility around the pandemic), its tracking error averaged zero.”
Donald Grimes, an expert in economic forecasting at the University of Michigan, has been analyzing another economic indicator: real disposable income per capita in the U.S., which typically grows 2% to 3% each year but is almost the same as it was in February 2020, just before the pandemic.
“A growth period this weak is unusual outside of recessions,” the university wrote of Grimes’s findings. “From an income growth perspective, we are in a recession-like period.”
Personal after-tax income is also estimated to drop 5.6% this year, the most since 1932, according to Grimes, because government benefits related to the pandemic, such as stimulus checks, are coming to an end.
“The reason we are not in a recession now despite this weak income growth is because people accumulated huge amounts of excess savings in 2020 and 2021 when their income was high, but they couldn’t spend it,” the university wrote. “They are spending that savings now.”
In any case, “recessions are notoriously hard to predict in advance,” said Sinclair, the economics professor at George Washington University. “It’s pretty easy to say a recession is coming at some point in the future based on our past experience. It’s much harder to quantify exactly when, how long, and how deep.”
Shalett, the Morgan Stanley investment expert, said that if the economy does enter a recession, it “is likely to be shallower and less damaging to corporate earnings than recent downturns” because of current economic factors and previous trends.
“Historically, damage to corporate earnings tends to be more modest during inflation-driven recessions,” Shalett wrote. “For example, during the inflation-driven recessions of both 1982-1983, when the Fed raised its policy rate to 20%, and 1973-1974, when the rate reached 11%, S&P 500 profits fell 14% and 15%, respectively. This compares with profit declines of 57% during the Great Financial Crisis and 32% during the tech crash.”
Moreover, key industries, such as housing and automotive, are in good shape, she said. “For autos, production rates are below prior peaks due to semiconductor shortages,” Shalett wrote. “As supply chains clear, order backlogs could keep manufacturing activity uncharacteristically high for a recession.”
The state of the labor market is encouraging, she added: “Not only is the labor market tight, as defined by unemployment rates, but it is also showing record-high ratios of new job openings to potential applicants. This suggests that, rather than laying off current employees, companies may first reduce their open job postings, potentially delaying the hit to unemployment.”
