Is a Recession Coming?
In the first two quarters of 2022, U.S. Gross Domestic Product decreased–dipping 1.6% in the first quarter and 0.9% in the second quarter (Burrows 2022). The dip sparked debate over whether the U.S. economy was in a recession in the first six months of the year. A commonly used definition for a recession refers to when GDP shrinks for two consecutive quarters. However, in the third quarter, U.S. GDP rose 2.6% in a better-than-expected growth report (Cox 2022). The growth in GDP has slowed fears of a looming recession. However, many Americans and economists still see indications typical of a recession.
How do we define a recession?
Informally, many people view a recession as a period of at least two consecutive quarters of GDP decline. However, this does not mean that a recession is officially declared. The determination is up to the National Bureau of Economic Research’s (NBER) Business Cycle Dating Committee. The NBER looks at a variety of economic indicators before declaring a recession—a determination that is usually made months after a recession begins. The NBER considers the overall size of the economy, which includes GDP, employment, spending, and production levels when making the declaration (Schaul and Fowers, 2022). This multitude of measures makes declaring a recession more complicated than it initially appears.
How do the economic indicators look now compared to a typical recession?
U.S. GDP grew in the third quarter, following two consecutive quarters of GDP contraction. However, most of the growth came from a narrowing trade deficit. This narrowing is a one-off occurrence and will not affect future forecasts to the same degree. The other drivers of GDP growth in the past quarter were increases in consumer spending, nonresidential fixed investment, and government spending. Capital Economics chief economist Paul Ashworth notes that this growth is not expected to be sustained as exports fade and demand falls due to increasing interest rates (Cox 2022).
One of the clearest signals of a coming recession is an increase in unemployment and job losses. However, the job market remains fairly strong. The unemployment rate sat at a low of 3.7% in October (Cox 2022), rising slightly after a 50-year record low of 3.5% in September (Rugaber 2022). The U.S. also added 261,000 jobs in October, above Dow Jones’s estimate of 205,000, although that represents the slowest growth in jobs since December 2020 (Cox 2022). Bloomberg senior economist David Wilcox explains that a contracting overall economy would feature weak employment numbers (Schaul and Fowers 2022). Economists typically view a 0.5% rise in the unemployment rate over several months as an indicator of a coming recession (Rugaber 2022), but the U.S. economy is not currently exhibiting those characteristics.
In addition to employment levels, consumer spending is another key indicator that is used by the NBER to determine whether the economy is in a recession. Despite high inflation, consumer spending remains strong with spending on services continuing to rise even as purchases of goods have fallen. In the third quarter, spending on services rose by 2.8%, but goods spending fell by 1.2%, growing overall 1.4% (Cox 2022). Rising prices have put a strain on Americans’ spending power, with inflation outpacing wage gains. Average hourly earnings have risen 4.7% compared to a year ago (Cox 2022), but in October, the Consumer Price Index–a measure of inflation–has risen 7.7% over the last year. Inflation remains uncomfortably high, but the October numbers were well below the estimates of around 8% and represented the smallest year-over-year CPI since January (Goodkind 2022). The slower growth in inflation may lead the Federal Reserve to slow down interest rate hikes. The Federal Reserve has previously announced they will likely increase rates by 50 basis points after increasing by 75 basis points in November (Siegel 2022). Nevertheless, inflation continues to outpace wage growth. Combined with high-interest rates, consumers are likely to continue to face downward pressure on their spending. Furthermore, Walmart has noted that customers have reduced spending on discretionary items, such as clothing, causing the retailer to reduce its profit outlook. However, spending on services continues to return to pre-pandemic levels (Rugaber 2022).
Production levels are also key to understanding the overall state of the economy. Industry and manufacturing, though only a minor fraction of the economy, tend to be sensitive to economic changes. The indicators in these industries appear mixed. The Industrial Production Index, which considers the value of items made in the U.S., exhibits growth that far outpaces previous recessions. However, real manufacturing and trade sales have dropped, which tracks with patterns from prior recessions (Schaul and Fowers 2022).
With the economic indicators seemingly all over the map, it is hard to determine whether the economy is headed toward a recession. Economists have noted that, though an unofficial definition, when the economy contracts for two consecutive quarters, a recession almost always follows (Burrows 2022). Another good predictor of recessions, known as the inverted yield curve, has also been exhibiting concerning signs recently. The inverted yield curve occurs when a 10-year Treasury bond yield dips below the yield of a shorter-term Treasury bill. Typically, longer-term bonds will have a higher yield, but inverted yield curves indicate that investors are expecting an economic downturn that will cause the Federal Reserve to cut interest rates due to an oncoming recession. Since July, the yield on a two-year Treasury bond has been higher than the yield for a 10-year bond. (Rugaber 2022). In late October, the yield on a three-month Treasury bond also rose over the 10-year bond, which is an even stronger indicator of a recession (Rugaber 2022).
What is different about right now compared to previous recessions?
Recessions bring economic pain. They are often characterized by low home prices, low stock prices, and high unemployment (Burrows and Waggoner 2022)—all of which hurt households and consumers. Federal Reserve Chairman Jerome Powell has noted his intentions for a “soft landing” approach, where the economy weakens to the point where hiring and wage growth slow to bring inflation back to the target of 2%, but without causing a recession. However, exogenous shocks, such as the Russia-Ukraine War and China’s COVID-19 lockdowns make that task very difficult. As such, Powell has stated that the Federal Reserve will continue to raise interest rates to slow inflation even in a recessionary economy. Higher rates may cause businesses to slow investments, causing hiring to slow and leading to layoffs. If widespread layoffs occurred, and the economy loses jobs, the public may respond by reducing spending (Rugaber 2022) which could bring further economic downturn and propel the economy further down the road to recession.
Many economists, including Powell, do not think that the U.S. is currently in recession, but many also expect a recession to begin by the end of 2022 or in 2023 (Rugaber 2022). If a recession is to occur in the near term, it is likely to be less damaging to corporate profits than other recent recessions. The reason for this difference is that this recession appears to be inflation-driven, rather than credit-driven. The 2008 Great Recession and 2000 dot-com bust were both driven by debt excesses, whereas the current economic cause appears to be the excess cash circulating the economy due to large amounts of stimulus spending during the pandemic. Previous inflation-driven recessions, such as the 1973-1974 and 1982-1983 recessions, saw corporate profits dip only 15% and 14% respectively, compared to a 32% drop during the dot-com bust and a 57% drop during the Great Recession (Schalet 2022).
The current economy is in a more robust position than in previous recessions, meaning a coming recession could be milder than in the past. University of Chicago economist Thomas Coleman notes that without a crisis like the Great Recession or COVID-19, a recession will look more like those of the 1970s and early 2000s, causing a lot of harm but without the painfully high levels of job losses that characterized the past two recessions. Coleman adds “All of our thinking is based on the last 20 years of recession. I’m not sure that’s a good guide” (Schaul and Fowers 2022).
What are the implications of a recession? What steps should households take during this recession?
Recessions can be an uncertain time for households that are strained financially. However, recessions can also provide an opportunity to direct money away from costly investments, like home purchases, and toward new investments. Paying off credit card debt is a great way to spend money during a recession as the interest rate is essentially equivalent to the return on investment, which will be higher than most investments during a recession. Similarly, bonds tend to rise in value during a recession, assuming the cause of the recession was not increasing interest rates. Typically, when the NBER first declares a recession is a great time to purchase stocks, as investors can foresee a recovery before the NBER, and stocks will begin to rise as the NBER’s official declarations lag (Burrows and Waggoner 2022).
How we characterize a recession is a lot more complicated than the common definition regarding two consecutive quarters of GDP decline may suggest. With economic indicators seemingly all over the place, it is difficult to determine whether we are on the path toward imminent recession. However, Wilcox notes that “every recession is unhappy in its own way” (Schaul and Fowers 2022), so a recession may well be coming–just one that looks very different from its predecessors.
References
Burrows, Dan, and John Waggoner. 2022. “Recessions: 10 Facts You Must Know.” Kiplinger.com. Kiplinger, June 8, 2020. https://www.kiplinger.com/slideshow/investing/t038-s001-recessions-10-facts-you-must-know/index.html.
Burrows, Dan. 2022. “Are We in a Recession? Here's What the Experts Say.” Kiplinger.com. Kiplinger, July 28, 2022. https://www.kiplinger.com/investing/604988/are-we-in-a-recession-heres-what-the-experts-say.
Cox, Jeff. 2022. “U.S. GDP Accelerated at 2.6% Pace in Q3, Better than Expected as Growth Turns Positive.” CNBC. CNBC, October 27, 2022. https://www.cnbc.com/2022/10/27/us-gdp-accelerated-at-2point6percent-pace-in-q3-better-than-expected-as-growth-turns-positive.html
Cox, Jeff. 2022. “U.S. Payrolls Surged by 261,000 in October, Better than Expected as Hiring Remains Strong.” CNBC. CNBC, November 4, 2022. https://www.cnbc.com/2022/11/04/jobs-report-october-2022-.html
Goodkind, Nicole. 2022. “A Better-than-Expected Inflation Report Sends Stocks Surging.” CNN. Cable News Network, November 10, 2022. https://www.cnn.com/business/live-news/stock-market-inflation-cpi-report/index.html
Rugaber, Christopher. “Explainer: How Will We Know If the U.S. Is in Recession?” AP NEWS. Associated Press, October 27, 2022. https://apnews.com/article/is-us-economy-in-recession-8be54810a122a2f84f0f7b3329ab1c9e.
Rugaber, Christopher. 2022. “How Do We Know When a Recession Has Begun?” Los Angeles Times. Los Angeles Times, August 26, 2022. https://www.latimes.com/business/story/2022-08-25/how-do-we-know-when-a-recession-has-begun.
Schalet, Lisa. 2022. “How Bad Could the next Recession Be?” Morgan Stanley, June 28, 2022. https://www.morganstanley.com/ideas/recession-2022-potential-how-bad.
Schaul, Kevin, and Alyssa Fowers. 2022. “Today's Economic Data Compared with Recessions over the Past 50 Years.” The Washington Post. WP Company, August 3, 2022. https://www.washingtonpost.com/business/interactive/2022/are-we-in-recession-data/.
Siegel, Rachel. 2022. “After Prices Rise Less than Expected, Markets Soar on Hopes of Lower Inflation.” The Washington Post. WP Company, November 10, 2022.
https://www.washingtonpost.com/business/2022/11/10/inflation-october-economy-fed/.