Are we in recession or not?

Inflation is out of control and we are heading into a recession. Except, wait: latest vacancies report indicates that the labor market is healthier than in previous years. So maybe we’re going to the legendarysmooth landingas the Federal Reserve tries to curb inflation. Also, please wait: This job posting was too much goodwhich means that the Fed will raise rates even higher – and economic problems are coming.

You are confused. We are confused. WHO Not embarrassed? The economic signals are pointing in different directions, and with each new release of data, a new batch of headlines comes up stating that our chances of a recession are higher or lower than before.

The reality is that everyone guesses. Let’s not forget that Economists are bad at predicting recessionsand the economy is especially weird right now. inflation, for example. it wasn’t a big problem for nearly four decades, but now it’s shaping how everyone thinks and talks about the economy. While this probably won’t make anyone any more certain of what’s going to happen next, it’s worth trying to understand what the indicators are saying when taken together.

It’s not a clear story and there are very different ways of presenting data. Here are two possibilities for the next few months and the evidence that supports or doesn’t support each scenario.

Strong labor market and decelerating inflation mean we’re heading for a soft landing

This is the most optimistic forecast for the economy in the near term, as it assumes that the Fed will continue to reduce inflation without speeding up rate hikes and without doing too much damage to the economy, especially in terms of the labor market. perhaps even avoid a recession altogether. In other words, this scenario assumes that we can not only eat our cake, but also eat it if it comes to achieving both goals. price stability and maximum employment.

And it’s not just sunshine buffs’ point of view to suggest we’re heading for a soft landing, who’s point of view is former Treasury Secretary Larry Summers put it down, “contradicting both economic theory and facts.” The latest released data for January 2023 shows that inflation has fallen to annual rate 6.3 percent after peaking at 8.9% in July 2022, and yet the unemployment rate remains stubbornly low at 3.4%, lowest in over half a century.

Usually when the Fed raises interest rates to counteract inflation (or the fear of it), one has to make a compromise: a rather lousy economy. In the 1980s, the central bank took a markedly aggressive approach to fighting inflation. raising rates to sky-high 19 percent reduce inflation from nearly 15 percent mark. The move triggered a deep—but perhaps necessary—recession, and the episode influenced the thinking not only of economists and Fed officials in subsequent decades, but also of ordinary Americans.

But one reason history may not repeat itself is the fundamental difference in the current labor market. You may remember that before the pandemic, the US economy was booming. Much of this has to do with relative strength of the labor market, as broad growth in sectors ranging from healthcare to construction has resulted in historically low unemployment and booming labor force participation rates. And now it looks like we’ve got that economy back in many ways – with very low unemployment and many, many vacancies. This is unlike when the Fed began its super-aggressive approach in the late 1970s, when inflation and unemployment were much higher and the economy was struggling with a “stagflation” crisis.

“The job market is so tight it’s hard to see how we can experience something like it was in the 80s,” he said. Fernando Martin, Assistant Vice President in the Research Division of the Federal Reserve Bank of St. Louis. Louis. “You won’t see a big increase in GDP growth or anything like that. But until we start seeing signs that the labor market is starting to deteriorate, it’s hard to start predicting a recession in the traditional sense.”

Finally, if you consider that the recent inflation we have seen was largely a by-product of tangled supply chains, then there is another reason for optimism. The signs point to supply chains improved since the height of the pandemic, which potentially contributed to lower inflation and suggests that the Fed can continue to cut prices without resorting to 1980s-style monetary engineering.

“The Fed is trying to reduce aggregate demand, but while rebuilding supply chains, they don’t need to cut aggregate demand so dramatically that we actually get a rise in unemployment,” the report says. Carol BinderProfessor of Economics at Haverford College. “Therefore, I think a soft landing seems possible – and even quite likely.”

Inflation is out of control and the labor market is too tight – so we’re probably in for a hard landing.

However, let’s not get too excited. Several economists we spoke to warned that not all indicators are as good as they seem, and a recession could still come.

The logic behind this is quite simple: while inflation appears to be declining, it is not slowing down as fast as the Fed wants. And this really strong labor market could be too strong for the Fed, because if workers are in demand, not jobs, employers will be forced to raise wages. This can then lead to higher costs for consumers as companies try to offset this while people also have more money to spend. To prevent this from happening, the Fed will almost certainly continue its rate hike journey, which could cause the economy to slow too much.

“Inflation has a long way to go by any measure, and I don’t see how inflation can be brought down as wages rise,” he said. Jonathan WrightProfessor of Economics at Johns Hopkins University. “And given the rather tight time horizon, I think the Fed would be wrong to do too much.”

The argument that economists like Wright make is that yes, a soft landing is possible, but conditions must remain near ideal for it to become a reality. And Wright said a lot of things can go wrong. On the one hand, there may not be much competition for jobs, but the proportion of people working or actively looking for work (62.4% in January 2023) even lower than before before the pandemic (63.3 percent in February 2020). “What you would like to see is that everyone is back in the labor force, but for older workers, labor force participation seems to be consistently lower,” he said. For him, this means that the current labor market trajectory is unsustainable – and preventing high wage growth (which could lead to higher inflation) will require stronger intervention from the Fed than we have already seen.

Another sign that the Fed could soon get even tougher, Wright said, is that financial markets are not behaving as if the Fed has consistently raised rates for nearly a year. For example, the interest rate on a mortgage. dropped for a few weeks in January after growth through most of 2022. They flared up again last couple of weeksbut it was a wake-up call for Wright, who said overall financial terms were “much easier” than they should have been, given the Fed’s actions, and that could undermine the Fed’s work, prompting them to push for even more aggressive rates. trips in the future.

Recessions can also be hard to see while they’re happening – there’s a reason why official definition of recessionby the National Bureau of Economic Research is retrospective. And there are several signs that the economy may already be weakening. For example, industrial production index decreased both in November and December, and remained at the same level in January, which caused assumption that we are already in a “manufacturing recession”. Business sales also a little shaky in the fallwhich may be another reason for pessimism.

Ryan Sweet, chief US economist at Oxford Economics, said he thinks a soft landing is possible – it’s just not likely given how many things have to go right to keep the economy on track. “We could get around [a recession]but it will take luck,” he said. However, this does not mean that we are in for a deep or prolonged economic recession like the Great Recession. If a recession does occur, Sweet believes, it will be because the Fed made a “political mistake” by raising rates too aggressively. “Historically, these have been moderate recessions,” Sweet said. “If the unemployment rate rises by a percentage point, it means that the economy is softening and it will be uncomfortable. But the NBER might not even date this as a recession.”

Of course, if the economics of COVID-19 has taught us anything, it’s that we shouldn’t be completely comfortable using these indicators for forecasting. This is not just a feature of the pandemic, as economists are infamous. for the wrong prediction when is the next recession. This uncertainty has affected our understanding of the economy during the pandemic as we went from boom to bust to potentially too much boom over the past 36 months.

Another potential danger lies in the assumption that all recessions look the same and that our not-so-reliable indicators can tell the whole story, even if they appear to have accurately predicted our fate. Martin mentioned one key indicator of a recession that pundits are looking at, an inverted yield curve:predictedof the COVID-19 recession — but months before anyone became aware of the destructive potential of the virus.

“If you look at the data, the recession happened,” Martin said. “But you know [the inverted yield curve] had nothing to do with it. It was a completely unexpected shock and a cautionary tale about indicators and predictive power.”

Maybe the lesson is that we fly blind, or that our economic navigation can be very accurate. However, regardless of the outcome, we will find out in the coming months and years whether our economic engines have made a hard or soft landing on the proverbial tarmac.