Why are We Talking About a Recession? Economists Weigh in
Stocks plummeted on August 14, 2019 amid worsening economic fears after U.S. Treasury yields briefly inverted, flashing a warning sign for a coming recession. (JOHANNES EISELE/AFP/Getty Images)
Fears of a potential U.S. recession have been cropping up with increasing frequency in recent weeks, and the Trump administration’s escalating trade war with China hasn’t helped matters. To understand why there is growing talk of recession and how it relates to the trade war, we spoke to two economists, who explained how uncertainty about trade policy has impacted business sentiment and left American companies unsure of how to proceed.
These interviews have been edited and condensed for length and clarity.
Why has talk of recession started to crop up?
Megan Greene, senior fellow at the Harvard Kennedy School: Amongst economists in particular, talk of recession has been really high for the past year. What really started it was the realization that we’d provided all this fiscal stimulus with the tax bill and the spending bill, and that would actually peter out by the end of this year.
There have been other things, particularly the trade war, that have caused a lot of headlines that have made talk of a recession more mainstream than economists and investors trying to figure out when it’ll happen.
A recession in this year is pretty unlikely, it would just be hard to get that given the growth we’ve had in the first half of the year, so you’d need deeply negative numbers in the third and fourth quarter for the year to average out. It depends on how you define recession as well. If you use the definition of just two quarters of negative activity, then that would be a little easier. But I still think it’s unlikely. I also think that a recession next year is pretty unlikely. I’d say the probability goes up in 2021.
Peter Ireland, professor of economics at Boston College: I think for a couple of different reasons. It is true that in the first half of 2019, economic growth and inflation have both been slower than what we had hoped for and expected as of this time last year. When the rate of economic growth slows, even though it remains solid right now, it’s natural that concerns of a recession begin to emerge.
Even more important, I think, is the fact that economic risks around the world have also increased noticeably — most significantly, uncertainty about trade policy. But more broadly, the Chinese economy seems to be slowing down noticeably. Threats of a more serious slowdown in economic growth in Europe have emerged. Maybe you could say concerns about Brexit figure into that too, there it’s a little more difficult to see how that would have a big effect on the United States. But the point is, a combination of noticeably slowing economic growth coupled with all of these threats, it does mean that people are right to be worried.
What are some factors or conditions that could push us closer to a recession?
Greene: I think we’re in a manufacturing recession, which is just to say the manufacturing industry is seeing two consecutive quarters of contraction. We had a manufacturing recession in 2015, 2016, but it didn’t turn into an economic recession largely because the Fed didn’t tighten then. They backed off of their plans to tighten, so that eased financial conditions. This time, we can’t really rely on the Fed to do our bidding because financial conditions are already pretty easy.
There are worries that a manufacturing recession will seep through into an economic recession. But I would point out that only 11 percent of U.S. economic growth is from manufacturing and 8 percent of employment. It’s not a huge piece of the economy. The U.S. consumer accounts for 70 percent of growth in the U.S., and the U.S. consumer continues to look pretty strong.
If the manufacturing recession were to seep through into an economic recession, it would have to be transmitted through the consumer, and there are three main ways I could see that happening. The first is, as the manufacturing industry slows and industrial production falls and business confidence falls, companies start cutting back. That would affect their investment, but it would also affect their hiring. So if the labor market were to weaken, that would affect consumer spending. The second way is if there are a whole bunch of headlines about trade wars and currency wars, and geopolitical risk and consumers get spooked and consumer confidence falls significantly — that would affect consumption as well. And then the third way would be if there were a stock market crash, and that really hurt some people’s wealth because they were holding so many stocks and then they reined in their spending.
Ireland: Right now, if you take a look at the sources of the slowdown in the first half, it’s entirely in the investment sector and that’s part of what suggests that trade policy or uncertainty about trade policy is playing a big role.
On the other hand, if you look at workers and consumers, the economic outlook has been and remains really quite strong. Unemployment’s low, labor force participation and wages finally have started to go up, consumer spending is very, very strong. It resonates with what we see — workers and consumers going around, stores and restaurants are full of people, everybody on the street it seems has a brand new car or S.U.V. There’s a lot of confidence on the part, I think, of the ordinary American consumer.
The big question is: If we are going to have a recession soon, it’s going to be because the weakness in manufacturing somehow spills over and affects consumers as well. But there’s no sign at all that that’s happening, yet.
How much of this is linked to the Trump administration’s trade war with China?
Greene: Business investment has been pretty bad. There was hope that the tax bill would encourage a whole bunch of new investment but that hasn’t happened, and a big reason why is uncertainty around trade. I’ve heard by talking to CEOs of companies and Fed presidents, they report that companies are saying that there’s so much uncertainty around trade that they were thinking about investing, but they’ve gone ahead and decided to hold off.
So it’s not that firms are cutting back yet, but they’re not going out and investing either. And I think that trade is a huge piece of that. We’re kind of in the worst scenario we could be in terms of business investment, because we’re going from one clear system to another. So previously, everyone considered globalization good, protectionism was considered bad. There were sort of international rules on trade that everyone played along. And now we’re in this weird middle ground where it’s not totally clear that globalization is all good. The U.S. is putting out some pretty protectionist policies, we’re imposing tariffs, and we might be going to a new system. Even if that system were a totally protectionist system where we decide globalism is bad — as an economist I think that would be a bad thing — but businesses would figure out how to operate in that new system. It’s just this middle ground where we’re in transition that’s really hard for businesses because they can’t figure out what the rules of the game really are.
Ireland: Uncertainty about trade policy definitely seems to be a big factor. Now, that said, there are other factors at play as well. It seems like the Chinese economy is slowing down anyway, and it’s also true that there are ongoing problems in Europe regarding Italian debt problems, Greek debt problems have not completely vanished, there’s Brexit. Trump doesn’t really have anything to do with any of that. I would say it’s a significant factor, but it’s not the only one.
Everybody understands that China will be uniquely China no matter what in the same way that the United States must be the United States no matter what. We may share values and systems of government to some extent with Europe, but our way is ours and their way is theirs. But for decades, it looked like China was moving closer to the American system of government and of economics with free markets and closer to democracy. And lately, it seems like they’re moving in the opposite direction. Things like serious concerns about intellectual property or ordinary Americans hearing about Chinese hackers interfering with United States information systems — it just gives you a bad feeling that instead of being friends with differences that could work out, maybe we’re not so close friends after all. If that’s the way things go, it’s going to be true — patterns of trade, patterns of doing business and even worldwide political considerations are going to be different in the future than they were in the past. That’s certainly going to have an impact on the economy as well.
What are some warnings signs of a recession that we should be on the look out for?
Greene: You could look at PMI data — purchasing managers index. Companies are asked about their expectations for new orders and employment, output and input costs. And any score above a 50 reflects an expansion, and any below 50 reflects a contraction. The PMI data tends to lead a recession by a couple of months, so if you see manufacturing and services going to contraction then that’s a good indicator that a recession is coming. [Note, on Tuesday it was reported that the PMI fell below 50, the lowest point since January 2016.]
We’ve seen the PMI data outside the U.S. for manufacturing fall below 50, so that’s worried some people. But in most developed countries, actually in China as well, services are a much larger percentage of growth than manufacturing. I think seeing both manufacturing and services fall under contraction would be an indicator.
I would also say employment data tends to be backwards looking, because it’s just reporting who was hired last month but it’s a high frequency indicator, so it comes out every month. As a result, it’s also a pretty good indicator of a recession. You find that when unemployment rises for a couple of months in a row, then that’s a good indicator that there’s a recession coming.
Ireland: What I would really look for, because the economic picture has been so sharply divided between business spending and the consumer-worker side of things — if we were heading into a recession later this year — what we’d start to see are the monthly employment figures coming in significantly slower, so instead of a 100,000, 150,000 or 200,000 new jobs per month, it would be more like 50,000 or even negative — distinctly subpar employment growth. Likewise, if we saw the unemployment rate tick back up, if people were being laid off, that would be a concern. And then third, if we began to see serious weakness in consumer spending.
Is there anything the U.S. can do at this point, from a policy standpoint, economic standpoint, that reduces the risk of recession?
Greene: It depends on which economic policy makers we’re talking about. I know that the Fed has cut rates and may well do so again, and that can help interest-rates-sensitive sectors like mortgages and cars, auto loans. That could be one contributor. But generally, I think businesses aren’t holding back on investment because borrowing costs are too high, it’s because of uncertainty around trade, so I don’t think the Fed is going to be the game changer this time around that it has been in the past.
More powerfully, if we could come up with some kind of resolution on trade policy, that would be really helpful. Generally, anything that can help provide clarity on rules would help businesses figure out how to operate in that system. So trade’s the most obvious one. Otherwise, in terms of avoiding recession — because rates are already pretty low and cutting them probably won’t help much — getting a fiscal stimulus would be really helpful to counteract a recession. I just don’t think it’s very realistic.
Ireland: If you think like an economist and ask where are the incentives for the main players in the game, both Chinese officials and the Trump administration do have an incentive to get some kind of arrangement worked out — maybe not to solve all the problems but to diffuse them later this year or early next. I think the incentives are for the two groups to minimize some of the uncertainty and that will help, too.