Jeez, you try to get the new year off to a good start and all of a sudden everybody’s talking about the next recession. The Wall Street Journal warns of “weak readings” in manufacturing and construction activity; forecasters are marking estimates for the current quarter down to 1 percent or even lower. Economist Andy Levin, who knows of what he speaks, presents data that “reinforce the view that the U.S. economy may be operating at stall speed.”
You ask me, I see neither a bubble in a key sector nor resource constraints (overheating). To the contrary, underwhelming demand, low interest rates and very low inflation continue to characterize our six-and-a-half year-old economic expansion. So while we may well be facing slower growth than I’d like, I don’t see a recession around the corner. That said, I tend to throw in with economist Jeff Frankel, who recently averred that “[r]ecessions are not forecastable. A downturn is no more likely in 2016 than in a typical year, nor less likely.”
Still, 6.5 years is already longer than the average expansion over the past few decades, and so here’s the only kind of economic forecast you should trust: a conditional one. No one can reliably tell you what’s going to happen down the economic road. But I can tell you that if X does happen, then Y is likely to happen, too.
So here’s my conditional forecast:
Somewhere out there is the next recession. We are woefully unprepared for it and I fear that the likelihood that this will change by the time the next downturn gets here is low.
Broadly speaking, there are two policy lines of defense against a private sector contraction: monetary and fiscal policy.
Monetary policy is what central banks do, and their most powerful tool is the federal funds rate (ffr), a benchmark interest rate that influences the cost of credit throughout the economy. Through their control of the money supply, the Fed raises and lowers the ffr when they want to slow down or speed up, respectively, the growth rate. After holding the ffr at zero for years, last month they bumped it up a touch (if slowing the economy through a higher ffr seems counterintuitive to you given the data discussion above, join the club).
So what’s the problem? It’s zero. That is, once the ffr gets lowered down to zero, there’s not a lot the Fed can do to reduce borrowing costs and stimulate growth. As we speak, the ffr is still very low, between 0.25 and 0.50 percent. Especially given the weak outlook, the Fed is not likely to raise it too quickly. So there’s a non-trivial chance that the ffr won’t be far above zero when the next downturn hits, meaning they’ll have little traction from their main tool.
Think of the Fed as a fire truck and the ffr as a tank of water they use to put out a recession. They emptied the tank fighting the Great Recession and may not have time to fill it, constraining their ability to fight the next fire.
That leaves fiscal policy, meaning taxes and government spending on “countercyclical” interventions. And that, at least partially, invokes Congress. You see the problem.
That “partially” above is important. A good chunk of anti-recessionary, countercyclical policy is automatic. SNAP, or food stamp, rolls expand with need in recession, as does unemployment insurance. Both programs performed admirably in the last downturn (btw, this point strongly militates against turning SNAP into a block grant, as some conservatives advocate). But as economists Mark Zandi and Alan Blinder point out in this comprehensive overview of the full spate of countercyclical policies we threw at the deep recession of 2008-09, much countercyclical policy, including the Keynesian stimulus known as the Recovery Act, was discretionary. In 2010, for example, they estimate that the Recovery Act saved an estimated 2.6 million jobs and raised real GDP an estimated 3.3 percent above what might have otherwise occurred.
Among the many unknowns in all of this is who will be in Congress and the White House when the next recession hits. But even if the president understands the importance of fiscal policy — especially with the Fed’s water tank close to empty — it is far too easy to imagine a Congress more interested in re-litigating the “failed stimulus” (as conservatives up there call the Recovery Act) than one that would efficiently snap into action to fight the downturn.
I should also point out that there will be all kinds of caterwauling about the addition to the deficit from countercyclical spending despite the fact that, because it is temporary, its impact on the deficit tends to be short lived. Post 2012, the Recovery Act added virtually nothing to the deficit.
Ideally, we’d have more programs automatically trigger on such that discretionary policy was less necessary, but at least for now, that’s not the world we live in. (Ben Spielberg and I have a paper coming out soon on granular policy ideas to improve countercyclical policy.)
Simply put, in a period with very low interest rates, fiscal policy may well pack more punch than monetary policy and thus becomes that much more important, especially in recession. I don’t know when the next downturn will hit, but between now and then, I’ll be trying to help policy makers understand this reality.
I know … “good luck with that.”