The term “recession” is a heavy one. So heavy that some policy makers have gone to great lengths to avoid using it. Alfred Kahn, an economic advisor to President Jimmy Carter, periodically substituted the term “banana” when discussing the south side of the business cycle. Former Federal Reserve Chair Alan Greenspan, whose ability to obfuscate was unsurpassed, described a downturn as “a cumulative unwinding of economic activity.”
In the present day, the prospect of recession is raising alarm among households, firms, and investors. Many are worried that tight monetary policy will bring the current expansion, barely two years old, to a premature end. But while downturns are rarely welcomed, they are not always something to be feared. And attempts to prevent them may prove more costly over the long run.
Global economies have been experiencing business cycles for centuries. Typically, the kindling of excesses in supply or demand is ignited by an external event that prompts a change in sentiment. From there human nature takes over, adding amplitude.
Monetary and fiscal measures can lean against swings in either direction. Recent history suggests that the practice of policy has become highly refined; the United States experienced three of the longest expansions in its history between 1982 and 2020. Only one of the recessions that occurred during that interval, in 2008, could be described as severe.
This experience bred the notion in some corners that recessions were avoidable, and that the tradeoffs between growth and inflation were not as significant as they had been in the past. It seems hard to recall now, but the concern in 2019 was that inflation was too low, and some Fed officials were worried about missing growth opportunities by not easing further.
The pandemic provided a rude interruption. The demand and supply destruction that occurred in the wake of Covid-19 was immense, and occurred very suddenly. Policy makers responded accordingly. In the United States, Congress passed fiscal measures totaling about one quarter of the country’s gross domestic product. For its part, the Fed nearly doubled the size of its balance sheet to finance the effort.
With the benefit of hindsight, this appears excessive. The stimulus created immense amounts of pent-up demand, which collided with the supply constraints that appeared in the markets for energy, durable goods, and labor (among others). Inflation accelerated slowly, then suddenly.
Central banks around the world have found themselves behind the curve. After initially diagnosing inflation as transitory, the Federal Reserve was forced to retire the term and confront a more lasting problem. A slow normalization would not do, as inflation broadened and expectations were at risk of becoming unmoored. The Fed has raised rates by two percentage points in the last six months, one of the more rapid tightening efforts that it has ever attempted.
The goal is a soft landing, an outcome that has rarely been achieved. The interval of the mid-1990s is held out as the ideal, but the U.S. economy is a lot different today than it was back then. The secular factors that helped keep inflation in check for decades—globalization and productivity—are now in retreat. A recession may be the price to pay for getting inflation back into a tolerable range, and it may be a price worth paying.
When real GDP fell in the first two quarters of the year, some observers suggested that the Fed had already gone too far. But the Fed didn’t begin raising rates until March, and financial conditions are still on the easy side of neutral. So it is hard to lay blame for the first half at the Fed’s feet. Further, it was high inflation that produced the negative outcomes, deflating nominal results to the point that they were below zero. In this way (and many others) tighter monetary policy today can be beneficial to economic growth over the longer term.
Nonetheless, markets became convinced that interest rates would not reach the levels suggested in the Federal Open Market Committee’s “dot plot.” If they did, the Fed would have to beat a hasty retreat because of the accumulated damage to economic activity. For most of the past two months, forward expectations for overnight rates have reflected significant declines next year.
The Fed must guard against pausing or reversing its efforts prematurely. The stop/start policy pattern seen 40 years ago was not good for growth, inflation or investors.
The last two American recessions have been on the more traumatic side, and that experience anchors today’s perceptions. But looking over a longer period, recessions are more likely to be short and mild. And the difference between a soft (or soft-ish, to use the Fed’s term) landing and a mild recession is not that significant for a long-term economic or investment outlook.
The interval ahead will be uncomfortable for monetary policy. Critical voices will be raised, and congressional testimony will be strained. But the Fed will be well advised to stay its current course and to avoid excessive fear of bananas.
Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to [email protected].
The Federal Reserve Can’t Back Down on Inflation in the Face of Recession
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The prospect of recession is raising alarm among households, firms, and investors alike.
Spencer Platt/Getty Images
About the author: Carl Tannenbaum is the executive vice president and chief economist at Northern Trust, and former head of the Federal Reserve’s Risk section.
The term “recession” is a heavy one. So heavy that some policy makers have gone to great lengths to avoid using it. Alfred Kahn, an economic advisor to President Jimmy Carter, periodically substituted the term “banana” when discussing the south side of the business cycle. Former Federal Reserve Chair Alan Greenspan, whose ability to obfuscate was unsurpassed, described a downturn as “a cumulative unwinding of economic activity.”
In the present day, the prospect of recession is raising alarm among households, firms, and investors. Many are worried that tight monetary policy will bring the current expansion, barely two years old, to a premature end. But while downturns are rarely welcomed, they are not always something to be feared. And attempts to prevent them may prove more costly over the long run.
Global economies have been experiencing business cycles for centuries. Typically, the kindling of excesses in supply or demand is ignited by an external event that prompts a change in sentiment. From there human nature takes over, adding amplitude.
Monetary and fiscal measures can lean against swings in either direction. Recent history suggests that the practice of policy has become highly refined; the United States experienced three of the longest expansions in its history between 1982 and 2020. Only one of the recessions that occurred during that interval, in 2008, could be described as severe.
This experience bred the notion in some corners that recessions were avoidable, and that the tradeoffs between growth and inflation were not as significant as they had been in the past. It seems hard to recall now, but the concern in 2019 was that inflation was too low, and some Fed officials were worried about missing growth opportunities by not easing further.
The pandemic provided a rude interruption. The demand and supply destruction that occurred in the wake of Covid-19 was immense, and occurred very suddenly. Policy makers responded accordingly. In the United States, Congress passed fiscal measures totaling about one quarter of the country’s gross domestic product. For its part, the Fed nearly doubled the size of its balance sheet to finance the effort.
With the benefit of hindsight, this appears excessive. The stimulus created immense amounts of pent-up demand, which collided with the supply constraints that appeared in the markets for energy, durable goods, and labor (among others). Inflation accelerated slowly, then suddenly.
Central banks around the world have found themselves behind the curve. After initially diagnosing inflation as transitory, the Federal Reserve was forced to retire the term and confront a more lasting problem. A slow normalization would not do, as inflation broadened and expectations were at risk of becoming unmoored. The Fed has raised rates by two percentage points in the last six months, one of the more rapid tightening efforts that it has ever attempted.
The goal is a soft landing, an outcome that has rarely been achieved. The interval of the mid-1990s is held out as the ideal, but the U.S. economy is a lot different today than it was back then. The secular factors that helped keep inflation in check for decades—globalization and productivity—are now in retreat. A recession may be the price to pay for getting inflation back into a tolerable range, and it may be a price worth paying.
When real GDP fell in the first two quarters of the year, some observers suggested that the Fed had already gone too far. But the Fed didn’t begin raising rates until March, and financial conditions are still on the easy side of neutral. So it is hard to lay blame for the first half at the Fed’s feet. Further, it was high inflation that produced the negative outcomes, deflating nominal results to the point that they were below zero. In this way (and many others) tighter monetary policy today can be beneficial to economic growth over the longer term.
Nonetheless, markets became convinced that interest rates would not reach the levels suggested in the Federal Open Market Committee’s “dot plot.” If they did, the Fed would have to beat a hasty retreat because of the accumulated damage to economic activity. For most of the past two months, forward expectations for overnight rates have reflected significant declines next year.
The Fed must guard against pausing or reversing its efforts prematurely. The stop/start policy pattern seen 40 years ago was not good for growth, inflation or investors.
The last two American recessions have been on the more traumatic side, and that experience anchors today’s perceptions. But looking over a longer period, recessions are more likely to be short and mild. And the difference between a soft (or soft-ish, to use the Fed’s term) landing and a mild recession is not that significant for a long-term economic or investment outlook.
The interval ahead will be uncomfortable for monetary policy. Critical voices will be raised, and congressional testimony will be strained. But the Fed will be well advised to stay its current course and to avoid excessive fear of bananas.
Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to [email protected].
Source: https://www.barrons.com/articles/recession-fears-inflation-fed-federal-reserve-51661457109?siteid=yhoof2&yptr=yahoo