What to expect from a recession 'everyone' sees coming: Morning Brief
It seems like "everybody" these days is saying we’re going into recession.
So: are they right?
I’ve covered the markets and the economy for four decades, and I can’t recall a time when more people — or at least prognosticators, economists, and bankers — were more certain that an economic downturn was imminent.
And if so many people believe that a recession is inevitable does that make it, well, inevitable? Or does it mean that a recession won’t occur? Or that any recession will at least be mild in nature? Ask this question enough ways and we're quickly into late-night dorm territory: What even is the economy?
But our primary economic problem right now is clear: inflation is running at 8.6% and the Federal Reserve is fighting this by raising interest rates. What caused this bout of inflation is mostly COVID-related, while the war in Ukraine added supply chain challenges and commodity pressures on top.
Lifting rates makes car loans and mortgages more expensive, which should temper demand. And as Fed chair Jerome Powell said in front of lawmakers this week: "I am trying to lower demand growth, we don’t know that demand actually has to go down, which would be a recession."
“There were times in the 1960s and 1970s when people could see that the Fed was going to raise interest rates and cause a recession to reduce inflation and I think we're possibly in that kind of situation,” says Laurence Ball, professor of economics at Johns Hopkins. “I think the risk of a recession now is higher than any time in the last 40 years. There have been recessions in the last 40 years, but they were not things that could have been predicted.”
To my mind, though, recessions can be mild and short if the causes are anticipated and less systemic, and more severe and longer if they are unexpected and less intertwined with the core economy.
Let’s look back at some recent downturns to outline these dynamics.
Exhibit A is the COVID recession of February-April 2020. Not only was this the shortest recession in U.S. history — or at least going back to the early 1800s — this downturn was, with a 19.2% decline in GDP growth, the biggest drop in output since the Great Depression.
Why? Well because the cause of the recession — the COVID-19 pandemic — was completely unexpected. This event (almost) literally shut down the economy, but in fairly short order, we figured how to cope, stimulated growth with spending packages, and the economy snapped back.
Exhibit B is the Financial Crisis, which triggered the Great Recession.
This downturn was triggered by the subprime mortgage crisis and lasted from December 2007 through June 2009, the longest downturn since the Great Depression. The accompanying 5.1% decline in GDP isn’t big compared to the COVID recession, but is still one of the sharpest drops since World War II.
And with the labor market taking years and years to repair itself after the Financial Crisis, the scars of this downturn and slow recovery are still with us today.
Leaving aside Michael Burry, Steve Eisman, and a few others, most people did not see a financial crisis in the offing back in the mid-2000s. I would argue the surprise factor here was high, which exacerbated the severity of this recession.
Exhibit C is the recession of the early 2000s, caused by the one-two punch of the dot com bubble collapse and 9/11. This recession lasted eight months — March-November 2001 — and the cumulative drop in GDP output was a mere 0.3%. So, not so long and not so deep.
Why? Well, perhaps because folks were strongly warning about the tech bubble before the crash. Additionally, the tech crash wiped out plenty of value from the stock market, but economy-wide job losses were comparatively modest. As for 9/11, that was a shock not unlike COVID, from which we snapped back.
So what does all this mean for our current economic predicament?
Well one part is easy. Or, easier. As I noted above, everybody and their mother is calling for a recession now, so any downturn would certainly be anticipated.
But what about the systemic challenges? How deep are the underlying causes of this prospective slowdown?
“I think that something major has happened,” says Robert Shiller, professor of economics at Yale. “People are really thinking of inflation and rates that were typical of the great inflation of the 1970s. People are really spooked by it suddenly.”
I would suggest the economy's pending challenges are more difficult than 9/11 or even COVID. Though, perhaps paradoxically, COVID is partly to blame for our current economic woes.
The real question, then, is how deep of an actual economic problem is there? I would argue, not so much.
We’re learning to cope with COVID and there are signs that supply chain snafus are easing, including chips for autos, particularly as China comes out of lockdown. Also, let’s not forget two great deflationary forces haven’t gone away: technology is still driving down costs and our population is aging.
As Paul Krugman pointed out in a recent Times op-ed: "When the working-age population is growing slowly or even shrinking, there’s much less need for new office parks, shopping malls, even housing, hence weak demand…there’s every reason to believe that we’ll fairly soon go back to an era of low interest rates."
We need to work through COVID and supply chain issues, and then technology and low secular demand — for better or for worse — will do the rest. As for labor shortages, with government assistance running out and the stock market down, I would anticipate that issue will run its course, too.
I think this means if we do have a recession, it will be relatively mild and not take anyone by surprise. Any recession that does come about should also not be terribly long.
Of course, some of this is pure speculation. Or perhaps wishful thinking. But when have economists — or columnists — ever been short on either?
This article was featured in a Saturday edition of the Morning Brief on June 25, 2022. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe
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