Why US is no longer heading for a recession but is actually in a recession

Paul Samuelson once said wryly that economists had predicted nine of the last five recessions. In other words, they over-predicted at least half the time. Cynics will say that, in truth, economists would kill for even this level of accuracy.

The problem is not just the prediction of recessions that do not happen. It is also the failure to predict recessions that do happen. The most famous example of this was in early 2008, when the US (and, indeed, the world) was on the verge of a Great Recession, and yet very few economists could see disaster ahead. Only after Lehman Brothers went bust did the enormity of the situation hit the most experienced pundits. No wonder Queen Elizabeth asked in puzzled tones why even Nobel-prize winning economists hadn’t warned of disaster.

Recession, Released on OTT
Do not be too harsh on economists. The future is unpredictable. Anybody venturing into the game of prediction knows, in his heart of hearts, that he aims to entertain as much as to inform. Discussing the future can be fun rather than an exercise in precision.

So, let me have a bit of fun too. Let me make a bold claim that the US is already in recession. Not heading for a recession but actually is in one.

We will know the truth only after several months. Economists have a rule of thumb: if GDP declines quarter-on-quarter for two successive quarters, the economy is in recession. Additional benchmarks are used by the National Bureau of Economic Research (NBER), the authority that officially declares recessions, to decide whether to utter the R word. But only rarely does the economy decline for two successive quarters without being declared a recession.

In the first quarter of 2022 (January-March), US GDP declined by 1.5%. Most pundits predicted a significant increase in the second quarter (April- June). The Atlanta Fed has a GDPNow model based on quick indicators, rather than regular data that arrive with a lag, yielding the fastest-possible forecasts that can change with fresh data several times a month. This predicted in May that GDP in the second quarter, seasonally adjusted, would grow by 1.9%.

But, by June 1, the same model had cut the quarterly prediction to 1.3% growth. On June 15, the model cut its prediction further to just zero. The trend suggests to me that the actual outcome will be negative. This implies two successive quarters of declining GDP, the benchmark for a recession. No wonder the stock markets have crashed.

Most pundits have been warning of stagflation, a mixture of high inflation and slow growth. Till a fortnight ago, few forecast outright GDP decline. But the mood is changing.

The US Federal Reserve looks foolish after persistently underestimating inflationary pressures in the last year. When inflation crossed its target of 2% in 2021, the Fed first dismissed this as a blip, then said the 2% target was an average rather than a ceiling, then ascribed rising prices to supply dislocations that would soon correct themselves. It grossly underestimated the impact of the Ukraine war. The net result was that inflation soared to 8.7%, more than four times the Fed target of 2%. In many jobs, the person in charge would have been sacked for incompetence.

The Narrative Picks Up Pace
The Fed is now raising interest in leaps and bounds to make up for lost time. It has raised the Federal funds rate thrice this year by a total of 150 basis points (bps), the last instalment being 75 bps in early June. It seems likely to raise rates by another cumulative 200 bps going into late 2023. Inflationary expectations are now high, and the Fed will have to act tough a long time to restore the credibility of its 2% target.

Meanwhile pundits are expressing fears that the Fed may go too far in monetary tightening, plunging the economy into recession. The Fed hopes to achieve a ‘soft landing’, slowing the economy (and inflation) without creating a recession. Yet, history shows that serious Fed tightening usually leads to a recession. Hence, some analysts forecast a recession by the end of the Fed’s tightening cycle in late 2023. However, rapid changes in the Atlanta Fed’s GDPNow model suggest that the recession may be here already.

Consumer purchases at mass retailers such as Walmart and Target have crashed hard and unexpectedly. So, their stock prices have been hammered. Amazon complains that it is saddled with huge unsold inventories. Sales of autos and other discretionary items have been hit hard as consumers postpone such purchases. This is not surprising since high food and fuel prices have left people with less money to buy other things.

US unemployment in May was a very low 3.6%. Which is why most analysts did not believe a recession was possible. Perhaps this will be a shallow recession with unemployment rising to no more than 5-6%. That will cause less pain than most recessions. But if the Ukraine war continues into 2023, the pain level will shoot up.

This article was originally published in The Economic Times on June 21, 2022.

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