Contrary to revised expectations – and robust economic data – the business cycle has not been repealed. Yes, Virginia, a recession is coming. But, like waiting for Godot, it is taking an awfully long time to arrive. When it does, its shape may look different, more like a mini recession than an outright downturn. This would be akin to a soft landing – a mild slide in output accompanied by few job losses. But if the weakness is pervasive and lasts more than a few months, it will nonetheless by labeled a recession by the National Bureau of Economic Research, the unofficial arbiter of when a business cycle starts and ends.
But what’s in a name. If such a Goldilocks outcome materializes inflation is brought to heel, the Federal Reserve will gladly take it. Indeed, policymakers have been scratching their heads for some time over why the economy hasn’t yet succumbed to the most aggressive rate-hiking campaign since the 1980s aimed at taming inflation. Following more than 5 percentage points of rate increases since March of last year, the economy’s growth engine has sputtered, but not stalled. In fact, growth was revised up significantly in the first quarter of this year – from 1.3% to 2.0% – and tracking models indicate that GDP staged a similar increase in the second quarter.
While many fret that the economy is undergoing a Wile E Coyote moment – suspended in thin air and poised for a sudden and steep drop – the skeptics of the economy’s staying power are losing advocates. Earlier this year, particularly after the banking turmoil that saw the collapse of some regional banks, expectations that a recession was just around the corner ran high. Investors priced in a near 100% chance of a downturn this year and the consensus of economists was equally convinced it would occur. Now, not so much. One reason: inflation is receding more rapidly than thought even as the economy’s underpinnings, most notably the job market, retains considerable firepower. To many, that means the Fed can ease up on the monetary brakes, removing one headwind that is the most likely to push the economy over the cliff. Is this wishful thinking? We’ll see. It would be a historic breakthrough for monetary policy, which has usually overshot the mark in its quest to rein in inflation. But it’s also rare to see a sustained decline in inflation amid an historically tight labor market and sturdy growth. We are rooting for Goldilocks, but still fear the wolf.
Still Chugging Along
Earlier in the year, most thought the economy would be on the cusp of, if not in, a recession by now. Clearly, it is not. Despite the runup in borrowing costs engineered by the Federal Reserve, tougher lending standards enforced by banks since the 9-day turmoil last March and, until recently, slumping household confidence, consumer spending has continued to keep the economy afloat. Retail sales did slow in June to a slim 0.2% gain, but from a robust 0.5% increase in May that was revised up from an initial estimate of 0.3 percent. The bad news is that inflation rose by the same amount, so real purchases were unchanged. The good news is that the higher prices did not discourage spending, as consumers had the wherewithal to purchase the more expensive goods.
With most data for June now in the books, the economy appears to have recorded a decent growth rate in the second quarter, rivaling the 2% pace in the first. That not only puts it above recessionary waters, but it’s also about equal to the average growth rate during the ten-year pre-pandemic expansion. Does the stubborn resilience of the economy mean that the Fed’s aggressive rate hikes failed to do the job? Not if you look at the main objective of its mission – bringing down inflation. In fact, you could say it is ahead of schedule. It took 16 months for inflation, as measured by the consumer price index, to surge from under 3% to over 9 percent, but only 12 months for it to drop from over 9% back to under 3 percent.
Of course, this dramatic turnaround does not truly describe what happened to inflation, as the headline boomerang masks stickier prices for much of the goods and services people buy.
Economists and policymakers like to exclude items whose prices are volatile to better understand the underlying inflation trend. This exercise paints an improving, but less impressive disinflationary picture. The so-called core CPI, which excludes food and energy items, slowed to 4.8% from a peak of 6.6% last September and prices for services, which are still in heavy demand, are rising at a 6.5% annual rate, down from an 8% peak in January.