What might the next recession in America look like

Recessions, like unhappy families, are painful in their own way.

The next thing, which economists see increasingly possible by the end of next year, is likely to confirm this. The recession in the US may be modest, but it could be prolonged.

Many observers expect any downturn to be much less daunting than the Great Financial Crisis of 2007-2009 and the back-to-back recession of the 1980s, when inflation was at its last. They say the economy is simply not out of control as it was in those earlier periods.

While the recession may be mild, it may end up being longer than the eight-month contractions of 1990-91 and 2001. This is because high inflation may prevent the Fed from rushing to reverse the recession.

“The good news is that there is a limit to how bad the situation can get,” said Robert Dent, chief US economist at Nomura Securities. “The bad news is that it will continue.” The former New York Fed analyst sees a contraction of about 2% starting in the fourth quarter and continuing into next year.

No matter what form the backlash takes, one thing seems for sure: There will be a lot of pain when you hit. In dozens of recessions since World War II, the economy has shrunk on average by 2.5%, unemployment has risen by about 3.8 percentage points, and corporate profits have fallen by 15%. The average duration was 10 months.

Even a recession at the shallow end of the spectrum is likely to result in hundreds of thousands of Americans, at the very least, losing their jobs. The battered stock market may go down further as profits fall. And President Joe Biden’s already low poll ratings could be dealt another blow.

“This will be the sixth or seventh recession, I think, since I started doing this,” said Scott Sperling, a veteran private equity expert. “Each of them is a different thing, and each of them feels the same pain.”

Signs of economic weakness multiply, with personal spending falling in May for the first time this year, after adjusting for inflation, and a gauge of US manufacturing hitting a two-year low in June. Michael Feroli, chief US economist at JPMorgan Chase & Co., responded to the latest data by lowering its mid-year growth forecast “dangerously close to recession.”

The depth and duration of the recession will be determined in large part by continued inflation and how much pain the Fed is willing to inflict on the economy to bring it down to levels it deems acceptable.

Mohamed El-Erian, chief economic adviser to Allianz SE, said he was concerned about a choppy scenario similar to the 1970s, in which the Federal Reserve prematurely eases policy in response to economic weakness before inflation is out of the system.

Such a strategy would pave the way for deeper economic downturns in the future and even greater inequality, said a Bloomberg Opinion columnist. El-Erian was at the forefront of warning last year that the Fed was making a big mistake in downplaying the inflationary threat.

What Bloomberg Economics Says…
The Fed won’t stop until it sees inflation has come down convincingly. This means that this Fed will slip into economic weakness, potentially prolonging the recession.”

– Anna Wong, Chief Economist of the United States

For his part, Federal Reserve Chairman Jerome Powell argued that while there is a risk of a recession, the economy is still in good shape to withstand higher Fed rates and avoid a recession.

A growing number of private economists are not convinced.

“A faltering economy is almost inevitable. The question of whether we will see a recession has gone beyond what the depth and duration of the recession is,” said Lindsey Begza, chief economist at Stifel Nicolaus & Co.

Just as it was some 40 years ago, the decline in GDP will be fueled by a central bank determined to rein in runaway consumer prices. The Fed’s preferred inflation measure is more than triple its 2% target.

But there are good reasons to hope that the outcome will not be as bad as it was in the early 1980s, or the 2007-2009 financial crisis, episodes in which unemployment soared to double-digit levels.

As Goldman Sachs Chief Economist Jan Hatzius has pointed out, inflation is not as ingrained in the economy or in the psyche of Americans as it was when Paul Volcker took over the Federal Reserve in 1979 after a decade of persistently strong price pressures. So today’s Fed won’t need that much lower to cut rate increases to more acceptable levels.

Leading academic economist Robert Gordon believes that the Fed’s job today requires about half the amount of inflation that Volcker had to do to get the economy done.

In addition, consumers, banks and the housing market are in a better position to weather the economic turmoil than they were before the 2007-2009 recession.

Private sector balance sheets are in good shape, said Matthew Luzzetti, chief US economist at Deutsche Bank Securities. “We haven’t seen as much leverage as we did” before the financial crisis.

Thanks to large government donations that boosted savings, household debt obligations amounted to just 9.5% of disposable personal income in the first quarter, according to Federal Reserve data, well below the 13.2% observed at the end of 2007.

Banks, for their part, recently passed the Fed’s latest stress test, showing that they have enough resources to weather a bad mix of rising unemployment, crashing home prices and plummeting stocks.

real estate market

And while housing has recently been hit by rising Fed-designed mortgage rates, it’s also in a better place than it was in 2006-2007, when it was overwhelmed by supply from a speculative construction boom.

Today, Doug Duncan, chief economist at Fannie Mae, said the United States has about 2 million housing units “less than our current demographic profile might suggest.” “That puts a somewhat lower limit on how large a recession could be.”

Duncan’s primary case is a sharp depreciation of the currency as house prices rise, but not outright.

In the labor market, a fundamental shortage of workers (thanks to baby boomer retirement and delayed immigration) is likely to make companies more cautious about layoffs in downturns, especially if mild.

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