Real gross domestic product (GDP) had a second consecutive negative quarter and government data showed it down -0.9 percent. This was actually an improvement over the first quarter, which was down at -1.6 percent.
But since it marks the second consecutive quarter of negative GDP, it meets the commonly held definition of a recession in a normal economy.
Naturally everyone in the media, almost none of whom have any education or experience in economics, jumped on the “we’re in a recession” bandwagon with bold headlines. This media echo chamber of “we’re in a recession” fuels public perception that we are in fact in a recession, which serves as negative reinforcement. I would venture to guess that 99% of the American public knows even less about economics than the reporters writing about it. Like inflation psychology, this negative reinforcement can become a self-fulfilling prophecy because it affects the way people perceive the economy and behave.
A majority of Americans, 58 percent, said in an IBD/TIPP survey released earlier this month that they think the U.S. economy is in a recession. This was up from 53 percent in June and 48 percent in May.
Well, thanks for that, feckless news media! Maybe you should try, oh I don’t know, actually trying to explain the economy instead of resorting to fear mongering (i.e., parroting GQP talking points).
Here’s a real possibility: If there is positive growth in the Third Quarter and the First and Second Quarters are revised upwards, can one really call it a recession? If so, it would be the shortest recession on record – and without the usual large increase in unemployment. That would be unprecedented. Here’s the problem: That Third Quarter data will not be available until after Election Day.
The thing is, the pandemic economy is anything but a normal economy, so it is entirely misleading to apply common definitions from the past (B.C. – before Covid) to the new economic circumstances in which we find ourselves (A.C. – after Covid).
To paraphrase a line from Star Trek, we must “boldly go where no one has ever gone before” as we chart a new course in a pandemic world. No one really knows what the rules of economics will be in this pandemic economy. (As has often been said, “economics is an inexact science.”) The new rules are yet to be understood and to be determined.
Derek Thompson explains at The Atlantic the The Everything-Is-Weird Economy:
The U.S. economy can’t be this weird forever. That’s what I keep telling myself, anyway. Eventually, I think, financial news will be boring again. Eventually, I pray, the U.S. economy won’t resemble some ever-morphing Rorschach blot. But after a year of shortages, a Great Resignation, and rising inflation, I’m still waiting for normalcy.
Here are three questions that get to the heart of what makes this moment so strange. Answering them, or at least attempting to answer them, could help indicate where things go in the second half of the year.
1. If gas prices are plummeting, why is inflation rising?
In the past two weeks, we’ve seen all sorts of evidence of “disinflation”—a decline in the rate of inflation. Retailers including Target, Gap, and Bed Bath & Beyond say they’re swimming in merchandise that they’ll have to discount. Oil prices have plunged, and gasoline prices are now coming down fast. The cost of shipping goods from China is falling. Microchip inventory is rising, which should bring down the cost of electronics. The prices of commodities such as natural gas, wheat, lumber, and other raw materials are plummeting.
Falling prices sounds like we’ve reached peak inflation. But on Wednesday, the Bureau of Labor Statistics reported that annualized inflation had surged to 9.1 percent. That’s the largest increase since November 1981. This seems utterly confounding. Inflation is a measure of the growth in prices. If prices are going down, how can inflation be going up?
The optimistic possibility is that the great disinflation has only just begun, and it wasn’t captured by the most recent report. The government’s latest data cover the month of June. But all those suddenly falling prices—on goods, energy, chips, and materials—are stories from the very end of June and early July. Plausibly, inflation was surging for much of early June and then peaked just as the calendar flipped. That means we should expect next month’s report to be much better.
But as the writer Noah Smith argues, something stranger and more disturbing may be happening. Perhaps inflation keeps contradicting optimistic headlines because the Federal Reserve has lost its magic touch.
That’s conceivably what happened in the 1970s. The oil shock came and went, but inflation kept raging as the Federal Reserve’s interest-rate hikes and forecasts did little to stabilize prices. Ultimately Fed Chair Paul Volcker jacked up interest rates to 19.1 percent in the early 1980s to demonstrate how serious he was about crushing inflation. (By contrast, today’s federal-funds rate is still below 2 percent.)
For the last year, the dynamic between the Fed and the economy has been a bit like a classic scenario of a parent driving a car while noise inflation steadily rises from the backseat. “Knock it off, please,” the parent says. But the noise rises. “I said: Knock it off!” the parent repeats. And the kids just get louder. This is what it’s like for the Fed to lose credibility; small interest-rate hikes are met with accelerating price growth. The only way to beat this sort of inflation is for the person in the driver seat to do something dramatic to prove that the status quo is intolerable. If the Fed raises interest rates by a full percentage point in its next meeting, that will be a lot stronger than requesting a moment’s silence from the back seat. That’ll be more like doing a sharp U-turn, and speeding in the opposite direction until the kids promise not to speak louder than a whisper for another 35 years.
I really, really hope that our Great Disinflation moment is right around the corner. I don’t want the Fed taking a hard left and yanking up interest rates to crush the economy. But we can’t rule it out yet.
2. If jobs are growing, why is the economy shrinking? And if prices are rising, why are wages falling?
If the only economic statistic you followed was the monthly jobs report, you’d assume that the U.S. is booming. Two years ago in June, the unemployment rate was 11 percent—the highest since World War II. Today, it’s 3.6 percent—just 0.1 points away from being tied for the lowest unemployment rate since World War II. That’s a remarkable turnaround.
But if the only economic statistic you followed was GDP—and the Atlanta Fed’s unofficial GDPNow forecast—you might assume that the U.S. is in a recession. The economy contracted last quarter, and the Atlanta Fed now estimates that with the pullback in manufacturing, construction, and exports, GDP is still contracting by about 1 percentage point, annualized. Two consecutive quarters of negative growth is typically (but not always) a sign of a recession.
No economy this crummy has been so amazing for finding work; but also, no economy this good for finding work has ever been this crummy. The gap between GDP and employment is the highest on record—a smashing violation of Okun’s law, the rule that employment and growth tend to move up or down in lockstep.
I’m sorry if this mystery already seems impossibly convoluted, but there’s more. Rising inflation typically occurs alongside rising wage growth. But that’s not happening right now. Weekly earnings growth has been falling; adjusted for inflation, average weekly earnings have turned sharply negative.
In sum, jobs are up, but growth is down; and inflation is soaring, but wage growth is falling. Huh?
One explanation is that rising material costs—such as energy, lumber, and metals—have dramatically held back growth, even as jobs are plentiful. That might also explain why average hourly earnings are decelerating, while inflation is accelerating: Materials costs have gobbled up the rest.
A second possibility is that companies are responding chaotically to rapid changes in demand, which is creating a “bullwhip effect.” Bloomberg’s Joe Weisenthal described it this way:
Goods become scarce. Companies fear that they will be unable to have goods to sell. They start to over-order key components, just to be sure they can keep operating. This makes goods more scarce. Eventually the cycle turns. Everyone has ordered too much. Orders get slashed. Gluts emerge. Prices fall. You know the drill.
Many companies might be at a moment in the bullwhip cycle where inventory has piled up [definitely in the retail store sector.] So they’ve slashed their orders, without yet laying people off. If enough firms did this at the same time, you’d see output declining in an economy with low unemployment. And that’s exactly what we’ve got.
A third possibility is that productivity has declined in the past few months, perhaps because of some combination of COVID, work-from-home ennui, and the aftershocks of the Great Resignation. Here’s one scenario: Let’s say you own a restaurant. Every month during the Great Resignation, one-seventh of your workers quit. Now you’ve got almost all-new kitchen staff and waitstaff, and you can’t train them fast enough. The new chefs keep messing up your nightly specials. The new waiters keep dropping plates. Every week, somebody seems to get COVID. Yes, your restaurant is fully staffed. But are you working at full capacity? Not a chance!
The chief executive of Delta recently described his airline like a real-world version of this hypothetical restaurant. “Since the start of 2021, we’ve hired 18,000 employees,” he said. “A chief issue we’re working through is not hiring but a training and experience bubble, coupling this with the lingering effects of COVID.” If many companies are stuck in this chaos bubble, it would make sense that employment is strong but output is a bit of a mess. A lot of new workers just don’t really know what they’re doing right now, and companies don’t have the capacity to train them.
Finally, the economic data might just be wrong, or temporarily janky. I’m not a Shadowstats guy. I don’t think the BLS is lying, and I trust that government analysts are doing the best they can. But monthly statistics are subject to sharp revisions. Maybe we are in a moment of transition, where the data are simply not going to make sense for a bit.
3. If consumers are miserable, why is leisure spending on fire?
Americans seem to be having a grand old time. Leisure travel is so strong thatairports can barely keep up. The movie-theater box office has already set several holiday-weekend records. Despite lingering COVID fears, hotel occupancy this summer is matching its 20-year average, and restaurants are packed.
But if you ask Americans how they’re feeling about the economy, you’d better bring a pack of tissues. Consumer sentiment has plunged to its lowest rate on record.
Paul Krugman talks about the media's negativity bias in economic coverage, "If you ask people how is your financial situation, it's favorable. If you ask them how is the economy, oh, it's terrible. That's a media failing." pic.twitter.com/Mdu50sczPv
— Sarah Reese Jones (@PoliticusSarah) July 31, 2022
I’ve previously suggested that Americans have an everything is terrible, but I’m fine mentality about the economy. Asked about the state of the country, we’re lugubrious. “Things have never been worse,” we tell pollsters over and over. Asked about our own lives or finances, our mood lightens significantly.
But maybe I should give the American public a bit more credit. With plunging stock values and medium-term Treasuries, the market seems to be betting on a recession or something like it. Perhaps Americans are internalizing that message. [See top of post.] Perhaps they intuitively sense that a recession is near, so they’re getting in their last thrills before the economy tips over.
Months from now, we may look back on the summer of 2022 and realize that this apparent weirdness was pretty self-explanatory, after all. We might look back and say:
America’s labor recovery was impressively swift because it coincided with an unsustainable boom in demand. Along with supply-chain challenges, this created a classic surge in domestic inflation, with too much money chasing finite goods and services. The Federal Reserve responded by turning up interest rates to crush demand. And this predictably caused a downturn in spending and investment. In the handoff from boomflation to recession, gas prices fell before inflation, growth fell before employment, and sentiment plunged before spending. In the end, it all went in the same direction: down.
What I’m describing here is a recession. And I don’t like how plausible the story sounds. If this is the most likely alternative to the everything-is-weird economy, then I say: Keep the American economy weird.
Nobel Prize winning economist Paul Krugman adds:
Ignore the two-quarter rule. We might have a recession, but we aren't in one now https://t.co/48qpo9uoQL
— Paul Krugman (@paulkrugman) July 27, 2022
The link to his Times opinion is for subscribers only.
Krugman takes a preemptive swipe at the “breathless commentary” that will erupt declaring a recession, telling readers “we won’t be.”
“That’s not how recessions are defined; more important, it’s not how they should be defined,” Krugman writes. “It’s possible that the people who actually decide whether we’re in a recession… will eventually declare that a recession began in the United States in the first half of this year, although that’s unlikely given other economic data.”
The National Bureau of Economic Research’s Business Cycle Dating Committee is the only group that can definitively say the country is in a recession based on a wide variety of factors, not just GDP.
So the official definition of a recession is that it is a period that the committee has declared a recession; it’s an expert judgment call, not a formula,” Krugman wrote. “So where did the two-quarter thing come from? Part of the answer is that the N.B.E.R. doesn’t make recession calls in real time. For example, while the Great Recession is now considered to have begun in December 2007, the dating committee didn’t make that call until December 2008.”
“Two quarters of economic contraction — a downturn sustained enough that it probably isn’t a statistical blip — seems, on the surface, like a reasonable criterion. But it’s not hard to see how it could be deeply misleading, even if the data are correct,” he continued.
“It would be ‘foolish’ to declare a recession solely based on Thursday’s findings despite the extremely high correlation with multiple consecutive quarters of negative GDP growth.”
“And what difference would a recession call make, anyway?” Krugman asks. “What should matter is the state of the economy — which is complicated — not the particular word we use to describe it.”
“I’m already hearing rumblings that the [Biden] administration will be applying a double standard if it refuses to accept the ‘official’ rule that two quarters of negative growth define a recession…. Well, there is no such rule. It’s quite possible that we will in fact experience a recession soon; it’s even possible, although less likely, that one has already started. But there’s no reason to use the R-word this week.”
In his column today, Paul Krugman follows up, How Goes the War on Inflation?
The U.S. economy is not currently in a recession. No, two quarters of negative growth aren’t, whatever you may have heard, the “official” or “technical” definition of a recession; that determination is made by a committee that has always relied on several indicators, especially job growth. And as Jerome Powell, the chair of the Federal Reserve, noted yesterday, the labor market still looks strong.
That said, the U.S. economy is definitely slowing, basically because the Fed is deliberately engineering a slowdown to bring inflation down. And it’s possible that this slowdown will eventually be severe and broad-based enough to get the R-label. In fact, on this question I think I’m a bit more pessimistic than the consensus; I think the odds are at least 50-50 that history will say that we experienced a mild recession in late 2022 or early 2023, one that caused a modest rise in the unemployment rate. But what’s in a name?
The real question is whether a moderate slowdown, whether or not it gets called a recession, will be sufficient to control inflation. And the news on that front has been fairly encouraging lately.
Obviously gasoline prices are down — almost 80 cents a gallon from their mid-June peak. (Remember those scare stories about $6 a gallon by August?) More important, business surveys — which often pick up economic turning points well before official statistics — are starting to suggest a significant drop in broader inflation. For example, a survey from S & P Global found that while private-sector companies are still raising prices, the rate of inflation is “now down to a 16-month low.”
Financial markets have noticed. The expected rate of price increase over the next year implied by inflation swap markets(don’t ask) has plunged from more than 5 percent in early June to 2.45 percent as of Thursday morning. Medium-term inflation expectations are also down.
Now, it’s much, much too soon to declare victory in the fight against inflation. There have been several false dawns on that front over the course of the past year and a half. And there’s plenty of room to argue about the level of “underlying” inflation — a vaguely defined term, but roughly speaking the part of inflation that is hard to get down once it has become elevated.
Serious economists I talk to are very anxious to see Friday’s release of the Employment Cost Index, which is supposed to measure what’s happening to, um, employment costs. Will it confirm or contradict the apparent slowing of wage growth visible in simple measures of average wages and at least one influential survey?
Well, we’ll have to wait and see. The good news is that policymakers appear willing to do just that. From my point of view, the most encouraging aspect of the Fed’s statement on Wednesday was the paragraph declaring that the committee setting monetary policy is prepared to be flexible, that it “will continue to monitor the implications of incoming information” and “would be prepared to adjust the stance of monetary policy as appropriate.” That’s a not-too-subtle rejection of demands from inflation hawks that the Fed commit itself now now now to a long period of extremely tight money.
As I suggested, early indications are that the Fed is winning its war on inflation, and doing so faster and more easily than most observers expected. What will it mean if these early omens are borne out?
The big answer, I’d suggest, is that we’ll need to re-evaluate recent economic policy. As everyone should know (although many probably don’t), the American economy has been remarkably successful at restoring jobs lost during the pandemic slump. This good news has been overshadowed by high inflation, leading to many declarations that U.S. economic policy got it all wrong.
But much of recent inflation reflects global forces outside U.S. control, which is why inflation has surged almost everywhere, not just here. And if the portion of excess inflation that does reflect U.S. policy can be unwound fairly quickly, without severe costs, a fair reading of the record would say that policy was actually very successful — that a temporary rise in inflation was a price well worth paying to avoid the kind of long-term depressed economy we experienced after the 2008 financial crisis.
[So] while the preliminary number for G.D.P. (which will probably be heavily revised) was negative, from where I sit the overall economic news looks fairly positive.
So buck up, America. The watchword is “fortitude” (courage in the face of adversity). The Covid shock to the economy is working itself out and the data shows that things are beginning to improve. Peak inflation may have already occurred, and all this recession talk is premature, and quite possibly misleading.
As the old proverb says “Don’t change horses in midstream.” (It means don’t alter your course of action, plan, or leader in the middle of a project, don’t change your mind at an inopportune moment). As I have posted many times over the years, Democrats Have Always Been Better For The Economy … Always. In the grand scheme of things, this Pandemic inflation is temporary. Americans have faced far worse, and survived and thrived.