‘Recession cure’ divides economists

(CNN Business) – The US economy is on the brink and may already be in the doldrums after the second quarter of contraction in activity. But indicators are mixed, fueling uncertainty about the way forward.

At the center of the debate among economists and policy makers is a fundamental question with enormous implications for America’s future: Which is worse, inflation or recession?

No one seems to agree on one or the other.

By raising interest rates, the Fed is making a big bet that a recession is worth the risk if it takes the heat off consumer prices, which are rising at their fastest pace in four decades.

But many economists and policymakers reject this idea, arguing that the supposed cure for stagnation would be much worse than the disease of inflation.

The Fed would certainly like to avoid both. It refers to a “soft landing” in which he raised interest rates enough to slow demand without stifling it completely. That would be the ideal outcome, although the Fed itself admits that the possibility of a further downturn is getting tougher.

“The Fed’s actions so far do not guarantee a recession, but they have actually made it more likely,” Josh Bivens, director of research at the left-leaning Economic Policy Institute, wrote in a blog post earlier this year.

This leaves us with two possible outcomes: an increase in inflation of the kind we have seen over the past year, or a recession that pushes prices lower with potentially higher unemployment and slower wage growth.

in favor of inflation

Bivens falls firmly into the “high inflation is bad, but recession is worse” camp. This is largely due to what stagnation does to the job market. “Recession actually means that your economy is, on average, poorer,” he told CNN Business.

Obviously, inflation is eating away at people’s wages, which is bad. (Consumer prices rose about 9% last month on an annual basis, while wages rose 5.3%.) But “the only thing we know about recessions is that they lower wages more reliably than inflation,” says Bevins.

One of the main arguments of its opponents is that inflation comes with a complex psychological problem. Once the idea of ​​permanently rising prices becomes an integral part of the consumer psyche, it can create a self-fulfilling cycle that is hard to break. This is no joke, says Bivens, but in his opinion, we’re not there yet.

In the United States, inflation has been stable at around 2% per year for most of the past four decades. Because of that, he argues, most people wouldn’t expect recent inflation to hold at around 9%.

“We must build on this expectation and this credibility,” he says.

Senator Elizabeth Warren is another prominent voice in the field, arguing that the root cause of our current inflation, including supply chain chaos caused by the pandemic and the war in Ukraine, lies outside the Fed’s purview.

Higher interest rates won’t fix higher energy prices, Warren wrote in an op-ed in the Wall Street Journal last week, and “they won’t break the corporate monopolies that Powell admitted in January could drive up prices because they can.”

When the Federal Reserve raises interest rates, it makes it more expensive to borrow money for individuals and businesses. This encourages everyone to spend less. Companies are postponing hiring, reducing working hours or laying off workers as demand dries up.

Warren wrote that this would “leave millions of people – disproportionately low-paid workers and workers of color – with lower salaries or no salaries at all.”

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Reducing the potential recession in Europe 0:50

Others argue that recessions, while not ideal either, are not necessarily disastrous. They can even be healthy.

Many who would argue about inflationary stagnation point to the 1970s, when hyperinflation rose, peaking at 14% in 1980. It required painful interest rate increases and two subsequent stagnations until the early 1980s, under the supervision of the Fed Chairman Then Paul Volcker, to finally break the inflationary cycle.

“A mild recession is now better than a severe Volcker-like recession, which will be necessary to stifle inflation if expectations take hold,” economist Noah Smith wrote in a blog.

Not all recessions are the same. The United States has experienced 34 recessions since 1857, or one recession every five years on average, according to data from the National Bureau of Economic Research. On average, each lasted about 17 months.

This means that the United States has ignored many recessions.

“People tend to tolerate moderate recessions, but worry a lot about high inflation,” Smith wrote in a Substack post.

But can stagnation really be a good thing? Sometimes, says Lakshman Akuthan, co-founder of the Business Cycle Research Institute, which identifies recession dates in 22 economies around the world.

“Recessions can be scrubbing events for the economy as a whole, driving incompetent giants out of business, resulting in more resilient competitors that can better meet customer needs,” he said in an email to CNN Business. “This time around, the economy has changed enough after the pandemic that new job opportunities have opened up.”

Achuthan points to some of the innovative companies that have emerged during recent recessions: Airbnb (founded in 2008), Uber and WhatsApp (founded in 2009) all emerged from the Great Recession of 2007-2009.

Conclusion

Whether or not the US is in recession now is a largely indicative debate. There are signs that the economy is cooling: housing demand is relaxing and consumer confidence is declining.

In most recessions, federal stimulus is a typical way to stimulate the economy and restore consumer confidence. Lifeline is unlikely to land this time.

“If the narrative becomes ‘we had to suffer a recession because we overspent in 2021,’ it makes you suspect no relief will come,” says Bivens. “I just think this is wrong all over the place.”

Jane Sahdi of CNN Business contributed to this report.

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