Recession talk is on the rise lately, and for an obvious reason: the economic data has been weak. Yesterday’s monthly update on retail sales, for instance, reveals that spending in the US rose a tepid 0.1%. Soft data can be found in several other indicators, including industrial production, the ISM Manufacturing Index, and flat-to-slightly-negative growth in the US monetary base. (For an overview, see last month’s economic profile.) The markets are also pricing in higher macro risk, as I discussed earlier this week. It all adds up to a troubling environment that may be an early clue that the US is headed for a new recession. But there’s an alternative scenario: slow/sluggish growth that feels like a recession but doesn’t lead to the standard NBER-defined downturn.
This is a controversial idea at the moment for the simple reason that the post-war history of US economic activity offers no precedent for economic activity that muddles forward while avoiding strong growth and deep slumps. Rather, the past 60-plus years have delivered variations on what can be described as relatively clear periods of growth, interrupted by brief recessions, which are then followed by robust recoveries, and so on. But there’s a growing suspicion that the “normal” cycle has been upended by the Great Recession and its aftermath. It’s premature to embrace this idea as fact, in part because the past six years since the recession ended are but one relatively short historical sample that’s still unfolding. Macro insight arrives slowly, and with a considerable lag. Meanwhile, all the usual complications that harass the thankless task of distilling macro “truth” are still with us. Nonetheless, the clues are starting to add up and it’s possible that we’ve entered what may be the twilight zone for the US business cycle.
How did we get here? The basic narrative is well known at this point. The worst economic downturn since the 1930s knocked the US economy for a loop in 2008-2009. The trouble was compounded by a severe financial crisis that pushed the system close to meltdown, both here and abroad. In short, 2008-2009 wasn’t your garden variety slump.
Neither was the policy response, that in some degree is ongoing. The Federal Reserve responded with an unusually strong dose of monetary stimulus (relative to history). Some economists say that it wasn’t sufficient, given the depth of the crisis. Others argue that it was too much and that it has gone on for too long. Those are issues for another day. What is clear is that the Fed’s various efforts to revive the economy have been extraordinary over the last six years relative to the central bank’s efforts in the previous six decades.
In fact, there’s a compelling case for arguing that the Fed’s efforts kept the 2008-2009 slump from turning into an even bigger debacle. Many economists argue, with a fair degree of credibility, that the US economy’s recovery from the Great Recession is largely due to monetary stimulus, which arguably has been the strongest policy response since the government took the US off the gold standard in the early 1930s. But at what price?
Is the tradeoff for keeping the economy from falling into an extended ditch a lackluster recovery that drags on for an unusually long stretch?
Some analysts argue that to the extent that the US is still recovering, more than six years after the last recession ended, the growth is due primarily to central bank action, such as it is. Without this “artificial” support, the economy would have drifted back into contraction, we’re told.
The problem, to continue this line of analysis, is that the depth of the Great Recession and the resulting blowback may roll on for years, perhaps decades. Some of the pain has been suppressed via Fed policy, but only partly so and with limited results. Nonetheless, the economy seems to be too weak to fend for itself and so monetary stimulus is arguably still needed to maintain forward momentum.
Economist Bob Dieli at NoSpinForecast.com relates an interesting analogy via email to summarize the unusual state of affairs in US macro in recent history:
Because both the housing sector and the financial sector were actively involved in the creation of the boom conditions that preceded the downturn, and because of what happened to them in the downturn, we have disabled, perhaps permanently, one of the basic transmission mechanisms of the prior business cycles. Simply put, in this recession we did more than stall the car. We blew out the transmission. And, when that happens, you don’t just start the car back up and get on the road.
The Fed has been trying rebuild the transmission and revive the economy’s capacity to shift into drive. The results have been mixed, although even the perma bears recognize that the US economy has been expanding in recent years, albeit weakly.
The question before the house is whether the quasi-artificially induced recovery is still highly dependent on monetary stimulus? In other words, is it still too early to start the process of tightening? Recent events offer support for answering “yes.”
In that case, when will the US macro trend be strong enough to support rate hikes? When will pigs fly? Nowhere on the near horizon, or so the recent data (and the aeronautical limits of even-toed ungulates) suggest. Even a “baby step” hike of 25 basis points is considered too risky at this stage by some economists. The Fed’s near-zero target policy that’s been in play since late-2008 needs to roll on, according to the reasoning from some (many?) corners. That may be enough to keep the US out of a classically defined recession, but it’s not enough to revive animal spirits in a degree that aligns with past recoveries.
In short, the US economy is betwixt and between. It’s not in a recession per se, and perhaps that fate will be avoided, courtesy of Fed policy. At the same time, the ongoing repercussions from the Great Recession will continue to weigh on the macro trend, repressing what might otherwise be a stronger degree of growth.
What’s the solution to break out of this straight jacket? Take your pick—the advice is all over the map. Depending on the pundit/economist, the road to salvation ranges from additional monetary and/or fiscal stimulus to a renewed embrace of austerity in one form or another that will resuscitate the economy’s natural ability to grow at solid rate sans artificial stimulants.
Debates aside about what might work (or not), the political and policy realities at the moment suggest that the foreseeable future will deliver something very close to what’s prevailed over the last several years: A central bank that’s reluctant to raise interest rates courtesy of an economy that’s growing modestly at best. Monetary policy may be able to keep an NBER-defined recession at bay, but only barely so at times… like right now, for instance.
Is this destiny for the next several years (or longer) for the US—and the world? Maybe, although the jury’s still out. We just don’t know enough about blowback after severe recessions to make definitive statements at this point. These events are rare (thankfully), which means that hard data of relevance is scarce. We have the 1930s and the last several years as data sets in the modern era. The first event was effectively resolved by a world war. Things are quite a bit more nuanced this time around, despite the ongoing presence of war around the globe.
This much, however, seems clear: how we think about boom and bust, the business cycle, recovery and recession, and related analytics may be in need of a major overhaul. Meantime, analysts are recognizing that we’re in a strange place for macro. Lacking the proper tools and theories to explain the new terrain it seems that there are more questions than answers. Fulcrum Asset Management posed what is perhaps the pivotal query in the new world order: “When is a global recession not a recession?”