I’ve added a closing comment at the end.
JB: No one can say when the next recession will hit, but what do you see in the economic picture that we should be considering in this regard?
MZ: Predicting recessions is indeed a dark art, but I think we are several years away from the next one. At the center of every recession is a serious imbalance in the economy and mirrored in the financial system. Think subprime mortgage and the Great Recession, or the technology bubble and the early 2000s recession. There are no such imbalances today. An overheating economy, characterized by accelerating inflation and rising interest rates, is another precondition for recession. This doesn’t describe today’s economy.
[I’ve added a figure here showing what households have to pay to service their debt as a share of total, after-tax income. You can see Mark’s point, as this ratio is way down from its pre-Great Recession peak.]
JB: So we shouldn’t be worried about that measly 1.2 percent print on the last GDP report?
MZ: I’m not worried. Abstracting from the quarterly vagaries of the GDP data, the economy’s growth is at close to 2 percent per annum. This is the same pace of growth that has prevailed since this economic recovery began seven years ago. Indeed, the weak GDP report for the second quarter was driven in large part by an unusually large decline in inventories. This sets the economy up for stronger GDP reports report during the second half of this year.
JB: You’ve mentioned the absence of overheating and the types of imbalances, or bubbles, that have hurt us in the past. Why are we doing better in this regard?
MZ: In part because much of this recovery has been about deleveraging — reducing debt — that built up during the housing bubble and was at core of the Great Recession. Regulators have also required the financial system to raise lots of capital and liquidity since the crisis, which incentivizes lenders to be more cautious. And they have used so-called “macro-prudential” tools to address any developing imbalances in the financial system. This is most recently evident in their efforts to slow lending for multifamily housing, which had been fueling a boom in multifamily building. They also successfully weighed against leveraged lending to businesses financing merger and acquisition activity a few years ago, and now have their sights on what has been aggressive vehicle lending. Regulators have been able to date to short-circuit the development of those imbalances that are the fodder for a recession.
JB: What about business investment? I’ve been underwhelmed by those numbers, especially given cheap, abundant investment capital.
MZ: Weak business investment over the past year is largely due to the collapse in investment in energy and related activities due to the collapse in oil prices. Multinationals have also turned more cautious given the weaker global economy, stronger dollar, and resulting weakening in their profitability. The good news is that these weights on investment are becoming less weighty. Worries that uncertainty created by geopolitical events and the presidential election are misplaced, at least so far. Business investment in research and development, the riskiest for of investment, has remained resilient.
JB: Why have interest rates been so damn low for so damn long? Is that not of sign of some fundamental weakness?
MZ: The economy isn’t back to full strength, as it is still working to fully recover from the Great Recession, the currently very low rates are more a reflection of tough economic conditions overseas. Global central banks are working hard to lift their economies through an aggressively easy monetary policy. The ECB [European Central Bank] and BOJ [Bank of Japan] are buying tens of billions of bonds and other financial securities each month in an effort to stimulate their economies, which is pushing down rates everywhere, including in the U.S. Global banks have also been big buyers of U.S. Treasuries and mortgage securities in response to tougher liquidity requirements imposed by regulators. The U.S. is also a safe haven, as nervous foreign investors want the safety of U.S. bonds, equity and other assets.
JB: Okay, that’s all very sensible and even kind of upbeat relative to a lot of the gloom one hears. But I’m going to play the Trump card. How does his candidacy fit into this mix? Were he elected, can the president, even one pretty seemingly detached from reality, really take the U.S. economy over the cliff?
MZ: If Mr. Trump gets precisely the policies he says he wants, then the economy will suffer a recession. His most notable economic proposals include higher tariffs on Chinese and Mexican imports, requiring over 11 million undocumented immigrants living in the U.S. to leave the country, and very large tax cuts that are not paid for and thus result in massively larger deficits and a much higher government debt load. Of course, given this economic reality, Mr. Trump may scale back his plans, and if he didn’t, a wary Congress almost certainly would. But as I say in a recent paper assessing the economic impact of his proposals:
“The upshot of Mr. Trump’s economic policy positions under almost any scenario is that the U.S. economy will be more isolated and diminished.”
JB: Finally, while I know you focus on all the moving parts in the economy, you pay particular attention to housing. Give us your take on that sector’s current well-being.
MZ: Housing has come a long way since the bust, and all the trend lines going forward look good. Providing a strong tailwind to housing are mortgage rates that are about as low as they have ever been and improving credit availability for first-time home buyers. Vacancy rates for homes for sale and rent are as low as they have been in over 30 years. That’s why I think the biggest issue for housing over the next several years will be a lack of affordable rental properties for low- and middle-income households, particularly in the nation’s urban centers.
I wanted to be sure to underscore Mark’s third answer, about regulators keeping a closer eye on systemic imbalances in the financial system. Too often in this town, such regulation is only discussed in terms of its costs, never its benefits. It’s always about “job-killing regulations.” But to the extent that these regulators are preventing the inflation of recession-inducing bubbles, they’re clearly job protectors, a key role we mustn’t fail to acknowledge and elevate. As I always say, the goal isn’t just getting to full employment, it’s staying there, and preventing financial bubbles from forming is an essential part of the recipe.