Is America heading for a recession? Rising inflation, stagnating economic growth and the dramatic fall in stock market values suggest yes. But continued job gains suggest the economy is firmly resisting a decline.
Specifically, the economy added 372,000 jobs in June, keeping the unemployment rate at 3.6% – just 0.1% from the lowest level in 52 years. Job growth has stabilized at a rate that would reach 4 million a year, and employers are reporting 11.3 million job openings, nearly double the 5.9 million Americans seeking active in a job.
At the same time, gross domestic product (GDP) shrank in the first quarter and some expect it to shrink once more in the second quarter. While the panel that classifies recessions looks at several economic variables, every past instance of two consecutive quarters of GDP decline has been classified as a recession. How to reconcile the decline in GDP and the increase in employment data?
One possible explanation is measurement error. For example, gross domestic income (GDI) continues to grow, which should also mean growth in gross domestic product because an economy’s income must equal its expenditure. Any downward revision to current inflation rates would also point to stronger real economic growth. Another possible explanation suggests that soaring consumer demand from trillions of dollars in Federal Reserve money creation and federal “stimulus” payments continues to ripple through the economy and only delays the inevitable recession.
It may also be that productivity has dropped. Indeed, if an economy adds millions of new workers while producing less output, it must mean that output per worker is decreasing. Economist Jason Furman estimates that productivity growth may have declined by up to 6% annualized so far in 2022, which would significantly exceed previous productivity declines.
Furman acknowledges that productivity data is noisy and subject to significant revisions, and that it is too early to determine the drivers of such a decline in productivity. Part of the decline might simply be a reversal of the productivity spurt that occurred during the pandemic. It may also be that the “great quit” driving many workers into new careers leads to transitory adjustments in productivity. Employers can accumulate workers in a competitive labor market. It is too early for definitive conclusions.
Nevertheless, as long as inflation remains high, it will lead to economic hardship, upheaval and possibly a recession. Lawrence Summers notes that “over the past 75 years, each time inflation has exceeded 4% and unemployment has been below 5%, the US economy has gone into recession within two years”. Today’s figures of 8.6% and 3.6%, respectively, meet these criteria.
The challenge for the Federal Reserve is to raise interest rates and unwind its balance sheet enough to stifle inflation without crippling the entire economy. His tools are blunt instruments which make threading this needle quite difficult.
However, the Biden administration and Congress have anti-inflationary tools that are less economically damaging and might therefore ease pressure on the Federal Reserve. For example, the Peterson Institute for International Economics calculates that even a 2 percentage point reduction in tariffs might reduce inflation by 1.3 percentage points and save $800 per household. The White House can also reduce inflation by abandoning its efforts to extend the Buy America rules, the Davis-Bacon rules imposing above-market wages, ethanol blends in gasoline and environmental restrictions on the construction of infrastructure. Perhaps more importantly, the White House should lift restrictions on oil, coal, and natural gas exploration, and ultimately abandon its Build Back Better plan on taxes and spending.
These policies would reduce inflation and thus allow the Federal Reserve to use a softer brake pedal. Many of these policies would also increase economic productivity, which is a free lunch that generally grows the economy without increasing inflation. In fact, if declining productivity is indeed dampening economic growth, these pro-growth policies become even more vital. These include streamlining the regulatory burden more broadly, encouraging investment and avoiding tax increases.
With inflation still high, the diverging data on economic growth and employment suggests a faltering economy that might go either way. Congress and the administration need to use their tools wisely and not just wait for the Federal Reserve to step on the brakes on the economy.
Brian Riedl is a senior researcher at the Manhattan Institute. Follow him on Twitter @Brian_Riedl.
