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ECONOMIC ANALYSIS: Are we careening toward a recession? My bet is 'no'

September 17, 2007

With a spate of market turbulence and a jobs report that counted 4,000 fewer net jobs last month, the discussion inevitably turns to the simple question: Are we heading for a recession?

In recent days, Larry Summers, the former Treasury secretary and Harvard University economist, mentioned the possibility before a conference in Europe, and Fred Mishkin, a New York Federal Reserve governor and Columbia University economist, delivered an academic paper describing the potential for pre-emptive policies in the face of housing stock price drops. He chose the Jackson Hole Fed summit for this talk, intentionally bringing a thoughtful scholarly paper into policy discussions.

The pedigree for worry couldn't be better.

The national economy has been growing since November 2001. That is an almost 70-month cycle, which is already 25-percent longer than the average of all expansions and the sixth-longest since the Civil War. Fortunately, being overdue for a recession is a poor predictor of future recessions.

My best guess on the short run is that financial markets will continue to stabilize under the watchful eye of the Federal Reserve and European Central Bank. I also believe job losses reported last month will be revised upward in later months as the newer data becomes available.

Here are the two most likely scenarios I see in the coming months.

Recession averted: The recent jobs report and lingering concern over housing markets (both home prices and financial market effects) make it easy for the Federal Reserve to lower interest rates later this month. I anticipate interest rates dropping by 1/4 or even 1/2 point, generating a calming influence on financial markets and easing borrowing pressure on folks busy making goods and providing services.

These cuts can be repeated as necessary in coming months if inflation remains at bay (though there's not much room for job growth with unemployment rates at near record lows). I expect current high levels of employment coupled with rate cuts should largely confine recessionary pressures. I think this is far and away the most likely outcome, but it's not the only possibility.

Mild recession: Inflationary pressures prevent the Federal Reserve from sustaining lower interest rates, so our economy is faced with the unhappy prospect of trading off some short-term pain for longer-run stability. The Fed wisely keeps inflation at bay, but the jobless rate rises, consumer spending dips, and concern over housing markets remains a persistent topic of editorialists.

The difference between these two outcomes is the potential for increasing inflationary pressures. Inflation is the great limiter of Federal Reserve policy action on unemployment. Fortunately, inflation has been quiet a long, long time.

Even if we dip into a recession in the coming months, Fed flexibility and the current strength of the economy suggest it will almost certainly rank as one of the mildest downturns on record.



Hicks is director of the Bureau of Business Research at Ball State University. His column appears weekly. He can be reached at bbr@bsu.edu.
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