The One About the Economy

“In retrospect, we needed to be lucky. Very lucky… Instead, we were unlucky, and lots of things went wrong.

The U.S. economy shrank at an annual pace of 1.4 percent in the first quarter of 2022, thanks largely to decreases in private inventory investment. Recession risks are rising. Deutsche Bank Research is forecasting a “major” recession by next year, a more dire scenario than its previous call for a “mild” recession… Goldman Sachs and Moody’s Analytics, among others, say there’s about a 1 in 3 chance of recession in the next couple of years.

There are several reasons recession looks more likely than it did just a few months back.

First and foremost: the Federal Reserve’s interest rate policies… Historically, most of the times the Fed has raised interest rates to get inflation under control, it (accidentally) tipped the economy into recession…

Factor No. 2 is the latest round of covid-related lockdowns in major manufacturing hubs across China. The Chinese government has shuttered factories and obstructed shipping of cars, electronics and other key consumer products. This will cause shortages and price spikes, increasing inflationary pressures and consumers’ expectations for more inflation in the months ahead.

Then there’s factor No. 3: the war in Ukraine. In addition to the immediate, unconscionable losses of Ukrainian lives and freedom, the conflict has also led to major disruptions in energy and food markets worldwide. Oil and natural gas prices have skyrocketed, visiting immediate pain upon the United States and especially Europe. The consequences for food prices are broader, and have not yet been fully felt…

Then, finally, factor No. 4: The myriad smaller shocks affecting food prices, including the avian flu, drought in California and self-sabotaging border theatrics in Texas…

Recession is not inevitable. But the outlook is darkening — first because of some poor decisions, and then because of a spate of really awful luck.”

“Where are we right now? Inflation is, of course, unacceptably high. Some of this reflects disruptions — supply-chain problems, surging food and energy prices from the war in Ukraine — that are likely to fade away over time. In fact, I’d argue that these temporary factors account for a majority of inflation, which is why just about every major economy is experiencing its highest inflation rate in decades.

But inflation, which used to be mainly confined to a few sectors strongly affected by the pandemic, has broadened. So I find myself in reluctant agreement with economists asserting that the U.S. economy is overheated — that overall demand exceeds productive capacity and that the two need to be brought in line.

The good news is that there’s essentially no evidence that inflation has become entrenched — that we’re in the situation we were in circa 1980, when inflation persisted simply because everyone expected it to persist. Every measure I can find shows that people expect high inflation for the next year but much lower inflation over the medium term, indicating that Americans still view low inflation as the norm. The fact that inflation is not yet entrenched offers the possibility of a soft landing…

What I’d argue is that there is a path through this difficult moment that needn’t involve a recession. And while the Fed can get it wrong — and will almost surely get it wrong to some degree, because these are tricky times — it can get things wrong in either direction. Right now I am, if anything, worried that the Fed is overreacting to inflation. But time will tell.”