October 28, 2018
Thinking About the Next Recession
The United States is on a countdown to the longest economic recovery in history since the 1840s at least. If we make it to June, we’ll have surpassed the lengthy 1992 to 2000 expansion, which was bookended by the two mildest recessions in the post-war period. So, with this good news abounding, it’s wise to think about the next downturn.
The economy is simultaneously showing very robust signs of growth and some amber warning lights. As I have written before, the good is news is that labor markets seem strong, jobs are plentiful and there are hopeful signs that wages are rising. The decline in labor force participation seems to be reversing, so economists surmise that there is extra enthusiasm among workers. Consumer and small business confidence are both very high. In short, all the good news that accompanies the peak of a recovery is fully in place.
The worrisome notes come in the form of a six-month drop in new housing starts, growing evidence of a manufacturing slowdown, and punishing tariffs (tax increases) that threaten the healthiest of economies. On top of that, the Tax Cut and Jobs Act led to the repatriation of only about 10 percent of the $2 trillion in assets held overseas. This means much of the booster that legislation is behind us. There is evidence of some credit bubbles, especially in auto loans. In short, all the bad news that accompanies a downturn is in place.
I’m not predicting a recession, in fact it might not be possible to predict a downturn. The point of this is to suggest that we should be thinking about downturns, and discuss how we stand with respect to the risks of a business cycle in families, business and government.
Household savings is, in inflation-adjusted dollars, beneath the levels of a decade ago. While most families have accrued some wealth due to home appreciation, we are not more prepared than we were in the last downturn. At least we can report that human nature is a reliable constant for both good and ill.
Business seems better prepared for a downturn. The nations’ collective balance sheets are fairly strong. If anything, the post-recession period has been notable for slower capital investment. To be honest, recessions are good for good businesses and bad for bad ones. It is fortunate for us that this is the case, as long as we have the collective wisdom to let the bad ones fail. And that lets us turn our attention to government.
One need not be armed with the wisdom of Joseph to determine that fat years should lead to savings to be used in lean years. In economics, we call this countercyclical fiscal policy. Whether or not that fiscal policy reduces the volatility of a business cycle is an open question. That it is a necessary budgeting problem for most governments is not.
Our federal government need not worry about going broke, as it possesses a printing press. Nonetheless, running a budget surplus during an expansion would seem an obviously prudent goal. We have not, and thus face the next downturn with a growing deficit. This is unwise.
State governments do not have a printing press and so must worry about downturns. The appropriate way to do this is through a Rainy Day fund, along with other fiscal reforms that stabilize revenues. At the state level, Indiana is surely a national leader in this area. We have a solid Rainy Day fund, and solvent state government operations.
Locally, the story is a bit different. Though many municipal governments have Rainy Day funds, they are not ubiquitous. More worrisome is the fact that several tax changes have made local revenues more volatile. The shift of burden from fairly stable property to local option income taxes will make cities and counties more sensitive to a downturn. The interim transportation bill accelerated local income tax payments, which give municipal government fewer warnings dealing with a downturn. Overall, that move might not make revenues less stable, since revenues from income and property will be impacted at different times.
When a downturn comes, be it in 2019 or later, Indiana is fiscally prepared but has many local governments that will face tough choices. Perhaps this would be a good time for a stress test of local government finances, given the many changes made to taxes since the Great Recession. Then again, it may well be too late.
About the Author
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