Are We In Recession Yet?

Spring seems to have brought a second quarterly decline in real gross domestic product (GDP). Since this marks the commonly understood definition of recession, many have declared that this unwanted turn has arrived. The White House, for pretty obvious reasons, is reluctant to use the dreaded word and has used technicalities to avoid doing so. Beside this sterile semantic argument, reality is nonetheless clear: the U.S. economy is weak and if not already in recession is likely to go into one relatively soon. Indeed, the economic harm of inflation and the financial strains of the Federal Reserve’s (Fed’s) efforts fight it make recession all but inevitable.

Certainly, a lot of the news looks bad. The GDP report for the second quarter painted a picture of widespread if not yet severe weakness. Overall, real GDP fell at a 0.9 percent annual rate. Real consumer spending slowed from a 1.8% annual growth rate in the first quarter to a meagre 1.0% rate in the spring quarter. Residential construction fell at an outright 14% annual rate in the second quarter, while business spending on structures and equipment, including technology, after a robust 10% rate of advance in the first quarter fell at a 0.1% annual rate in spring. Even government spending shrank in real terms, at a 1.9% annual rate. Beyond this important GDP accounting, the Purchasing Managers’ Index for July looked less than encouraging. It came in at a level of 47.5, well below the level of 50 that demarcates the distinction between growth and decline. One part of the Labor Department’s employment report, the part that surveys households, showed an employment decline of 315,000 for the month of June.

Not all figures, however, were downbeat. The Labor Department’s survey of employers showed a marked contrast from the picture provided by households, indicating a 372,000 jump in June payrolls. Retail sales, having slowed from their post-pandemic surge, still showed a better than 12% annual rate of advance in June, well above the rate of consumer price inflation. New orders for capital equipment rose at almost a 9% annual rate for the past couple of months, faster than inflation and showing a willingness among managers to increase productive facilities. Media outlets made much gloom over the report of a rise in initial claims for unemployment insurance to 251,000 during the week of July 16. That is slightly higher than the weekly average during pre-pandemic 2019, but that year showed very strong employment, so it may not be as bad as some have suggested.

Whatever the current balance of evidence, continued inflationary pressure says that the economy will tip in a negative direction. The issue is not just the frighteningly high inflation reports but that the fundamentals suggest persistence. To be sure, today’s inflation has immediate roots in ongoing supply chain problems and the effects of the Ukraine war, and these will likely lift. But the inflation also has more fundamental and roots — the legacy of over a decade in which the federal government engaged in considerable deficit spending that the Fed financed through extremely easy monetary policies. Consider that in just the past couple of years, the Fed has used new money to buy about $5 trillion in new government debt, the digital equivalent of financing government with the printing press and a classic prescription for inflation.

Because today’s inflation is so well entrenched, it alone could bring on recession. The longer it lasts, the more its distorting economic incentives will discourage saving and investment, the ultimate engines of growth. This kind of stubborn inflation will also force the Fed to take more extreme steps than it has to date. As dramatic as the Fed’s actions seem, they have hardly constrained credit or discouraged borrowing and spending. Consider that with the benchmark federal funds rate of 2.25% the interest paid on a debt will fail to compensate lenders for the lost buying power of the monies owed them. In other words, a strong inducement to borrow and spend remains. Before the Fed can brake inflation’s momentum, it will have to raise interest rates close to the prevailing rate of inflation. That is a long way from here and would certainly precipitate recession.

Fed Chairman Jerome Powell at his last press conference announced that the Fed in its anti-inflation fight will strive to achieve what he called a “soft landing,” that is avoid recession. He also told the reporters there that soft landings are “rare.” In effect, he put recession as the likely result of the Fed’s efforts. That economic setback will likely dominate the second half of this year and probably extend into 2023. If the Fed does its job with forceful policy measures, the economic decline should not extend too far into 2023. If, however, the Fed fails to act forcefully enough, the full extent of the economic setback may be delayed, but it will go deeper and last longer, for then the economy will have to deal with the distortions of a truly entrenched inflation.