(CNN Business) — The US economy is on a knife edge, possibly already in a recession following a second trimester activity contraction. But the indicators are mixed, fueling uncertainty regarding the way forward.
At the heart of the debate among economists and policymakers is a fundamental question with huge implications for America’s future: Which is worse, inflation or a recession?
No one seems to agree on one or the other.
Al raise interest ratesThe Federal Reserve is making a big bet that a recession is worth risking if it takes the heat off consumer prices, which are rising at their fastest pace in four decades.
But many economists and policymakers reject that idea, arguing that the supposed cure for a recession would be far worse than the disease of inflation.
To be sure, the Fed would like to avoid both. He points to a “soft landing” in which he raises interest rates enough to slow demand without stifling it completely. That would be the ideal outcome, although the Fed itself admits that the prospect of sustaining the landing is becoming increasingly difficult.
“The Fed’s actions to date do not guarantee a recession, but they have already made it more likely,” wrote Josh Bivens, director of research at the left-leaning Economic Policy Institute, in a statement. blog post earlier this month.
That leaves us with two potential outcomes: more inflation of the kind we’ve seen over the past year, or a recession that pushes prices down while likely rising unemployment and slowing wage growth.
in favor of inflation
Bivens is firmly in the “high inflation is bad, but a recession is worse” camp. That’s largely due to what a recession does to the job market. “A recession actually means your economy is, on average, poorer,” he told CNN Business.
Inflation clearly eats into people’s wages, and that’s a bad thing. (Consumer prices rose regarding 9% last month on an annualized basis, while wages rose 5.3%.) But, says Bivens, “the only thing we know regarding recessions is that they reduce wages much more reliably than inflation.”
One of the main arguments of its opponents is that inflation comes with a complicated psychological problem. Once the idea of perpetually rising prices becomes embedded in the consumer’s psyche, it can create a self-fulfilling cycle that is difficult to break. That’s no joke, Bivens says, but in his opinion, we just haven’t gotten there yet.
In the United States, inflation has been stable around 2% per year for most of the last four decades. Because of that, he argues, most people don’t expect recent inflation of around 9% to hold.
“We should build on that expectation and that credibility,” he says.
Senator Elizabeth Warren is another prominent voice in this field, arguing that the root cause of our current inflation, including the supply chain chaos caused by the pandemic and the war in Ukraine, lies far beyond the Fed’s jurisdiction. Federal.
Higher interest rates won’t fix rising energy prices, Warren wrote in a Wall Street Journal op-ed last week, and “they won’t break up the corporate monopolies that Mr. Powell admitted in January that they might be ‘raising prices because they can’.”
When the Federal Reserve raises rates, it makes it more expensive for people and businesses to borrow money. That encourages everyone to spend less. Companies delay hiring, reduce hours or lay off workers as demand dries up.
That, Warren writes, “will leave millions of people — disproportionately lower-paid workers and workers of color — with smaller paychecks or no paycheck at all.”
pro recession
Others argue that recessions, while not ideal either, are not necessarily catastrophic. They can even be healthy.
Many who would argue for an inflation-driven recession point to the 1970s, when runaway inflation spiked, peaking at 14% in 1980. It took painful increases in interest rates and two subsequent recessions to early 1980s, overseen by then-Fed Chairman Paul Volcker, to finally break the inflationary cycle.
“A mild recession is now preferable to a severe, Volcker-like recession, which will be needed to quell inflation if expectations take hold,” economist Noah Smith wrote in a blog post.
Not all recessions are the same. The United States has been through 34 recessions since 1857, or regarding one every five years on average, according to data from the National Bureau of Economic Research. On average, each lasted regarding 17 months.
That means the US has shrugged off many recessions.
“People tend to forgive mild recessions, but really worry a lot regarding high inflation,” Smith writes in a Substack publication titled “Yes, We’re Probably in a Recession, and That’s OK.”
But can a recession really be a good thing? Sometimes, says Lakshman Achuthan, co-founder of the Business Cycle Research Institute, which determines recession dates for 22 economies around the world.
“Recessions can be clean-up events for the economy as a whole, forcing inefficient giants out of business and giving rise to more agile competitors that can better meet customer needs,” he said in an email to CNN Business. . “This time around, the economy has changed enough following the pandemic that new business opportunities have opened up.”
Achuthan points to some of the innovative businesses that have emerged during recent recessions: Airbnb (founded in 2008), Uber, and WhatsApp (founded in 2009) all emerged from the Great Recession of 2007-09.
The conclusion
Whether or not the United States is in a recession now is largely a semantic debate. There are signs that the economy is cooling: housing demand is easing and consumer confidence is falling.
In most recessions, federal stimulus is a typical way to stimulate the economy and restore consumer confidence. Those financial lifelines aren’t as likely to land this time.
“If the narrative becomes ‘we had to have the recession because we overspent in 2021,’ it makes you suspect that no relief is coming,” says Bivens. “I just think it’s wrong all over the place.”
Jeanne Sahadi of CNN Business contributed to this report.
