Perhaps Milton Friedman Was Right

Enough already with the recession talk.

For at least six months many economists have been forecasting an imminent economic pullback or collapse that would crush the U.S. economy.

Like so many things forecast in the media it hasn’t happened. Not by a long way. A piece I wrote in June indicated there were few signs of recession just slower growth.

Still the calls of economic oblivion keep on coming relentlessly and yet no recession has emerged.

That failure and similar ones is probably the root of economist J.K. Galbraith’s quip: “The only function of economic forecasting is to make astrology look respectable.” And astrology is looking better every day.

Here’s what you need to know.

Sudden Unexpected Economic Shock?

First, recessions rarely if ever get forecast with accuracy. They tend to occur due to a sudden unexpected economic shock, according to David Ranson, director of research at financial analytics firm HCWE & Co. The phrase “sudden unexpected shock” is key here. If economists are predicting something six months or a year ahead then it isn’t sudden or unexpected or a shock. That would make it a very different sort of recession.

An example of that was the recession of 2020 caused by the totally unexpected COVID-19 pandemic and subsequent lock downs.

Likewise, in 2007 the subprime crisis seemed to pop out of nowhere and even the most informed Federal Reserve officials were in clear denial just a few weeks before the official start of the recession in December that year.

However, on August 7 that year then Fed chief Ben Bernanke made the following statement: “I think the odds are that the market will stabilize. Most credits [bonds] are pretty strong except for parts of the mortgage market,” as reported by The Wall Street Journal

The same day William Dudley, also a Fed official, said: “There is some strain, but so far it looks as though nothing s is really imminent in those areas.”

In other words, even when global financial armageddon was right around the corner Fed officials were blind to the onset of the Great Recession, a.k.a. the Global Financial Crisis (GFC.)

Or put another way, those with tons of economics training and access to loads of good data got surprised.

Recessions Get Called After the Fact, Usually

Second: Even the National Bureau of Economic Research, which determines the start and end of recessions takes a while to pinpoint the exact dates. For instance, the announcement of the December beginning of the GFC came a year later in December 2008. Likewise, the determination that the beginning of the 2001 recession was in March that year came eight months later in November that year.

In other words, it isn’t usually obvious what’s happening until its over.

Rubber Band Theory

Third: The economy tend to trundle along at its long-term pace unless a shock, such as the pandemic and its lockdowns, happens.

For instance, look at the chart below kindly provided by David Ranson at financial analytics firm HCWE & Co. It shows real or inflation-adjusted GDP growing at a rate of around 1% a year. The lockdowns knocked it off course and once they were lifted the U.S. economy began reverting to its previous 1% a year growth course.

Famed economist Milton Friedman, the father of monetarism, developed the plucking theory of economic cycles likening the post recession economic response to plucking a guitar string. The harder it is pulled down the fast and more vibrantly it snaps back to normal. I prefer the rubber band analogy, it works the same way and not everyone plays guitar

The chart shows pretty clearly that the economy snapped back with speed and vigor. and it also shows that the economy is growing. If it growing then by definition its not in a recession.

The question now is simple: What could move the economy off course?

No Shocks Here, Sir

Some point to rising interest rates. Yep interest rates are normalizing, but they are still low, indeed much lower than in the 1990s when the economy grew like gangbusters. I had a mortgage in the 1990s at around 7.25% — it didn’t stop me buying a house. Mortgages are still way lower than they were back then.

Perhaps what’s more important is the fact that these rate hike have been well-signelled by the Federal Reserve. In other words, we’ve all, businesses and consumers, have seen this coming for what now seems like an eternity. We’ve all adjusted to the new normal, which is probably a big part of what’s helping the economy continue to grow.

Put simply, the increasing cost of borrowing money hasn’t been a shock to anyone who has a radio or access to the web.

As one late-night radio talk-show once said: “I ain’t never been hit by a train I seen coming.”

Quite so. Me neither.