A Future Recession?
By Neil Tamhankar
Recessions are periods of economic downturn in which unemployment goes up and prices go down. The economy generally slows down and the total output decreases. Periods of inflation are basically the opposites of recessions, where prices increase and unemployment decreases. With the U.S economy currently experiencing the highest inflation it has had in 40 years, a recession does not seem to be in the cards. So why are so many economists worried about a future recession?
Causes of Recessions
Recessions are a natural part of the business cycle, along with inflation. Economies will experience both phenomena at various points in time. A major signal of a recession is GDP consistently decreasing. GDP is equal to the sum of consumer spending, government spending, business investment, and net exports (total exports - total imports).
Large decreases in government spending will significantly decrease GDP since government spending is a significant part of GDP. Lower government spending slows down the economy because less goods are being bought and sold. Large increases in taxes can also cause recessions because they discourage consumer spending; with higher taxes, people have less disposable income to spend.
Aggressive increases in interest rates can also cause recessions because higher interest rates lead to lower business investment and consumer spending. If interest rates on loans are high, businesses are less likely to take out loans to invest in capital and consumers are less likely to take out loans for large purchases like cars or homes. Additionally, consumers are more likely to save money in banks instead of spending it since the interest they earn on deposited money will be higher. Lower business investment and consumer spending lead to lower GDP.
All of the above causes were deliberate government actions that can cause recessions. However, there can be other causes, such as war, disruption of supply chains, and general events that cause businesses to lose money and slow down production.
The Case for a Recession
Economists predicting a recession have quite a strong case, for 3 main reasons.
1. The interest rate hikes. In response to the suffocating inflation the U.S is experiencing, the Fed hiked interest rates. If you remember from a few paragraphs ago, increasing interest rates aggressively can cause a recession, and these rate hikes were certainly aggressive. In late 2021, when inflation was beginning to rear its ugly head, the Fed deemed the inflation “transitory”, claiming it would fade. Because they were wrong and acted too slowly, they now have to raise interest rates by a lot more than they would have had to if they had begun earlier. These sharp increases have the potential to cause a recession.
2. The war in Ukraine. Russia’s unprecedented invasion of Ukraine has had devastating economic effects on the world economy, intensifying supply chain problems and contributing to global food shortages (Ukraine is a major wheat exporter, and the war has led to decreased wheat production in the country). The closure of Russian airspace has forced cargo planes to make detours and the war has increased difficulty for cargo ships in the Black Sea. Supply chain slowdowns have led to traffic jams at many U.S ports, especially the port of L.A. These slowdowns will lead to a decrease in output, which could cause a recession.
3. Last but not least, the ever-persistent pandemic. The coronavirus pandemic initially caused a recession, but the economy has since recovered. The pandemic has been the main cause of supply chain complications for the past couple of years but combined with these other events, it could help contribute to a recession. China’s recent lockdowns in Shanghai due to Covid outbreaks have worsened the supply chain crisis. Shanghai has the world’s busiest port, and the shutdown furthered supply chain backlogs.
The Case Against a (Severe) Recession
While a recession does seem likely, it is possible that it could be a mild one. Households accrued a whopping $2.5 trillion in excess savings between March 2020 and January 2022, mostly due to the massive stimulus payments the government gave out in the early days of the pandemic. If a recession does hit, households will have enough savings to weather the rough patch and keep up consumer spending.
Additionally, the unemployment rate is at a historic low of 3.6%. This strong labor market has contributed to the growth of wages, which have grown 4.5% between December 2020 and January 2022. Furthermore, the monthly job openings rate has consistently been around 7% for the last few months, with about 11 million job openings (5 million more than the number of unemployed people). With this many job vacancies, employers are desperate to attract workers, which has also contributed to wage growth. When added to the trillions of dollars in savings that Americans have gained, it is reasonable to say that the country has a soft cushion protecting it from a severe recession.
A recession is most likely coming due to interest rate hikes, the war in Ukraine, and the enduring pandemic. After inflation this high, an economic downturn is probably necessary for the economy to go back to equilibrium. But with a strong labor market and households doing well financially, the recession may not be too severe.
