September 17, 2007
The "R" Word
With a spate of market turbulence and a jobs report that counted 4,000 fewer net jobs last month, the discussion inevitably turns to the simple question: Are we heading for a Recession?
Last week Larry Summers, former Treasury Secretary and Harvard economist mentioned the possibility before a conference in Europe. Last week, Fred Mishkin New York Federal Reserve Governor and Columbia University economist delivered an academic paper describing the potential for pre-emptive policies in the face of housing stock price drops. He chose the Jackson Hole Fed summit for this talk, intentionally exposing a thoughtful scholarly paper into a policy consideration.
The pedigree for worry could hardly be better.
The national economy has been growing since November 2001. That is an almost 70 month cycle, which is already 25% longer than the average of all expansions and the 6th longest since the Civil War. Fortunately, being overdue for a recession is poor predictor of future recessions.
My best guess on the short run is that financial markets will continue to stabilize under the watchful eye of the Federal Reserve and European Central Bank. I also believe the job losses reported last month will be revised upwards in later months as the newer data becomes available. These outcomes are likely given the current policy climate and history of job reports. But, there are other policy tools available (and worries other than a recession). So, here are the two most likely scenarios I see in the coming months.
Recession Averted: The recent jobs report and lingering concern over housing markets (both home prices and financial market impacts) makes it easy for the Federal Reserve to lower interest rates later this month. I expect interest rates dropping by ¼ or even ½ point, generating a calming influence on financial markets and easing borrowing pressure on folks busy making goods and providing services. These cuts can be repeated as necessary in coming months if inflation remains at bay. (Though there’s not much room for job growth with unemployment rates at near record lows). I expect current high levels of employment coupled with rate cuts should largely confine recessionary pressures. I think this the far and away most likely outcome, but it’s not the only possibility.
Mild Recession: Inflationary pressures prevent the Federal Reserve from sustaining lower interest rates, and so our economy is faced with the unhappy prospect of trading off some short term pain for longer run stability. So, the Fed Wisely keeps inflation at bay, but the jobless rate rises, consumer spending dips and concern over housing markets remains a persistent topic of editorialists.
The difference between these two most likely outcomes is the potential for increasing inflationary pressures. Inflation is the great limiter of Federal Reserve policy action on unemployment. Happily inflation has been quiet for a long, long time. Due to the long statistical memory of inflation, the tamer it has been, the more docile it is likely to remain. So, even if we dip into a recession in the coming months, Fed flexibility and the current strength of the economy suggest it will almost certainly rank as one of the mildest downturns on record. A recession is still un-welcomed (even if it does free up stale capital and unleash creative destruction). Despite the long expansion and murmurings of the “R” word, this economist views an imminent recession as unlikely.
About the Author
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