By Mike Walden
A year ago, a large percentage of economists were predicting that by now, the economy either would be in a recession or clearly headed for a recession. I was among them.
But if the path to a recession was clear, we would now be seeing a downward-trending stock market, large job layoffs and rising unemployment, households tightening their spending — especially on nonessentials — and falling housing prices.
But instead, we’ve seen a different picture develop of the economy. The most followed measure of the stock market, the Dow Jones Industrial Average, is 1,000 points higher than it was last June. While there have been some layoffs in sectors like technology, economists continue to be surprised by robust increases in jobs almost every month. A higher percentage of people are planning vacations this year compared to 2022. And housing prices actually rose in April, the latest month available.
As a result, a recent poll of economists showed fewer than 50% think there will be a recession in the next year. This is exactly the opposite of the same poll in January when more than 50% predicted a recession in the next twelve months. Should you consider economists as being fickle? When asked that question decades ago, a famous economist replied, “When the facts change, I change my mind. What do you do?”
What has changed to make economists and others more optimistic about the economy? First is the fight against inflation. Although inflation is certainly still an issue, with the current rate well above the pre-pandemic rate of 1.8%, it has been steadily moderating from its peak of over 9% last year. A lower inflation rate makes it possible for more workers to receive pay raises that keep up with rising prices. When this happens, the worker’s standard of living rises.
A lower inflation rate allows the Federal Reserve (also known as the “Fed”) to ease up on its interest rate policy. Since early 2022, the Fed has been raising its key interest rate. This rate has gone from near 0% to 5%. When the Fed raises its interest rate, other interest rates typically follow. Just over the past couple of years, the 30-year fixed mortgage interest rate has gone from under 3% to 7%. Credit card rates have spiked from 15% to 20%.
Higher interest rates make it harder for households to buy homes, vehicles and anything that can be put on a credit card. Actually, this is the goal of the Fed. The Fed wants to slow consumer spending to take pressure off prices and thereby curtail inflation.
Yet, when the Fed raises interest rates, there is a good possibility spending will slow so much as to put the economy in a recession. This was the thinking earlier this year. Yet now — with the inflation rate almost cut in half — there is more expectation the Fed will stop raising interest rates, which means the chance for a future recession is lessened.
Together with the better news on inflation, the news continues to be positive in the labor market. For most people, the labor market is where they see the damage caused by a recession. Layoffs and unemployment force households to tighten budgets and reduce spending. The reduced spending translates into lower sales for businesses and likely more layoffs.
But rather than slowing, the pace of job gains has strengthened. The number of jobs added in May was much above expectations and twice as high as in April. One of the best predictors of an upcoming recession is a downward trend in job growth, and we’re not seeing that yet.
In my opinion, there are two explanations for the strong labor market. One is the return to the pre-pandemic economy. People are going out, eating at restaurants, taking trips, and returning to gyms and other personal services. These are all businesses that were hard hit during the pandemic and even afterward as many people were worried about a revival of COVID. For most, those worries are now in the past. As a result, the aforementioned sectors are seeing revivals in activity and are hiring more workers. Fortunately, more workers are now available for jobs. The labor force participation rate, which measures the percentage of potential workers who have jobs or are looking for jobs, is 99% of the pre-pandemic rate.
The second explanation is businesses continue to have memories of the days of severe labor shortages, and they don’t want to return to them. Hence, many businesses may be reluctant to lay off workers even if economic conditions warranted it. Some have called this a “hoarding” of workers, and if it is occurring, it certainly is helping workers.
So, the short answer as to why worries about a recession have cooled is simply that many numbers suggest the economy has improved. But don’t take this statement too far. There are still worries about the economy. Commodity prices have been slumping, which has often been a predictor of a recession. The Fed could still decide to further increase interest rates. With the Saudis announcing more oil supply cuts, gas prices could increase. Then, there’s the always unpredictable stock market. Investors could decide to turn pessimistic, resulting in lost wealth and lost spending, both of which are not good for the economic outlook.
There’s a third option in addition to the “no recession” or “yes recession” possibilities. I’ve named the third option, the “full employment recession,” or FER. In the FER, the job market remains strong, mainly as a result of the aftermath of the pandemic. But selected other sectors — commercial real estate, manufacturing, commodities and possibly big-ticket consumer purchases — retreat as they would in a typical recession.
I come back to a refrain I’ve used before: COVID has changed everything, at least for a while. I wouldn’t be surprised if it changed the look and feel of a recession. You decide.
Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.