Discover more from Stay-At-Home Macro (SAHM)
We are not in a recession, nor is one inevitable.
Americans are rightly angry about inflation. A strong labor market is not enough reason to celebrate. But, we are coming out of, not going into the hurricane.
Recession, Recession, Recession. The news is grim. Fears are rampant. Should they be?
I will say emphatically and with data to back me up: we are not in a recession now. Businesses added almost 400,000 jobs last month, and the unemployment rate held at 3.6% for the third month. That’s outstanding. That’s not a recession.1
I am not the only one who is feeling good about the labor market. Last month 7 in 10 people said they expect unemployment to decline in the next year or stay about the same. I do too. That’s not a recession brewing, at least not the expectation of one.
But it’s complicated. When asked directly about a recession in a different survey, about half of adults say one is already here.2 Again, I disagree, but it’s worth drilling down into how we might get from here to a recession or not.
How will we know a recession is coming?
Don’t ask people. Watch them.
Consumer spending is about 70% of the U.S. economy. So if people start spending a lot less, businesses lay off workers, leading to even less consumer spending, and so on. As a result, unemployment rises a lot. Other parts of the economy, like business investment or housing construction, can pile on, worsening the recession.
So, where are we now? Even after taking inflation into account, consumer spending rose nearly 3% during the past year through April, which is somewhat above average, and unemployment is low. A recessionary spiral has not taken root, though it could.
So why are so many big names like Jamie Dimon so gloomy? There’s value in preparing for the worst and hoping for the best. And it gets clicks.
Why does the Fed want workers to get smaller raises?
Inflation is too high.
What was the good news that I saw touted last Friday on Jobs Day? Wage growth is slowing (a bit). And that should make the Fed happy. Here’s the President of the Cleveland Fed, Loretta Mester, on the thinking:
Moderation in wage growth is not a bad thing. That’s a good thing. We need to see more consistent tempering of underlying demand.
By the way, her definition of “good” is common among Fed officials. Note well “tempering” is not slashing, though some pundits would welcome slashing to get inflation down. Regardless of the magnitude, this attitude has little to do with wages or workers or their families; it’s all about lowering inflation.
Why is less wage growth a “good thing,” even when inflation is high? The story goes like this: the Fed’s job is to get inflation down, which is high due to demand exceeding supply. The only thing the Fed can do is help lower demand. The Fed can’t tell people to spend less, but it knows income, including wages, is a crucial determinant of how much people spend. It is even more so than interest rates, which are rising “expeditiously.” Indirectly, the Fed has some effects on income, but so does a long list of factors. So, it cheers on moderation in wages, hoping inflation moderates with it.
It’s a delicate balance, and it’s easy to see why some believe the Fed will have to slam on the breaks to get inflation down and cause a recession. High enough interest rates will get people’s attention. But that would be more than “tempering” demand.
What else would help get inflation down?
More workers. More stuff. Less Covid.
Not everyone thinks demand is the primary driver of inflation. I don’t. We are coming out of a deadly pandemic, and no matter how loud some yell about the Rescue Plan, they can’t wish away Covid. No, inflation did not come back down quickly last year. (It was coming down in the summer. But then Covid came back again and again and again. Yes, demand came back stronger than supply, but there are signs that supply is catching up. That’s key to bringing inflation down with less hardship.
One example of something unusual happened during the pandemic: millions of people walked away from jobs and left the labor force at its start. Their return has been slow, though there’s real progress this year, with room for more.
It’s a “labor shortage,” not a “customer excess” that businesses have been complaining about. The best way to ease a labor shortage is to get more workers, not fewer customers. Wage growth would moderate some, and more people would have paychecks. Of course, the Fed can’t count on that; they have even less influence on supply, so they are focused on fewer customers.
Covid is likely making the return to the labor force harder. At the end of last year, among working-age adults, health limitations were the most common reason cited for not working. Not surprisingly, that fraction has risen since the start of the pandemic. Concerns about Covid were also a common reason. We are so focused on economic outcomes like inflation and the unemployment rate that we often forget Covid was a health crisis first and foremost. At least a million people died, and more are living with long Covid. It was unprecedented in its disruption. It’s also a tragic contributor to inflation. The Rescue Plan did not cause Covid. Workers getting raises didn’t either.
Many are adapting and getting back to work. Spending is starting to shift back to services. Production is ramping up. The best path to lower inflation does not involve the Fed. If the Fed isn’t careful, it could get in the way of more supply. People are more likely to rejoin the labor force when jobs are plentiful than when they aren’t.
Experts who pin inflation largely on the Rescue Plan and the demand it created are the gloomiest now. They see a severe recession as the only way to get inflation down. They see little role in more supply. I disagree. Though the timing is more uncertain—see last year’s mistaken prediction—there’s scope for more supply to come back, and it will matter for bringing down inflation without a recession.
We are not in a recession.
Consumers are spending. Businesses are hiring. The unemployment rate is low. That doesn’t mean everything is good. Inflation is high. But that’s not a recession.
The Fed is committed to bringing inflation down. But to do so, they need us to swap one hardship for another. Less consumption for less inflation. But that’s not the only way. More supply—more workers to hire or more stuff to buy—would reduce inflation too. That’s the better way but more uncertain and beyond the Fed.
The best would be if inflation came down and was not due to the Fed. The worst would be if it were all due to the Fed. And in between is some mix of the two. Regardless inflation’s coming down. Recession or not. Preferably not.
Addendum: The war in Ukraine and its adverse effects on energy and food prices are an additional hardship for many families and a further risk to the macroeconomy.
Your financial support would be valuable and help me write here regularly. As a paid subscriber, you will receive a regular, deeper-dive post on the Fed and the economy.
The views in this post are my own and do not represent anyone else.
The Sahm rule, my recession indicator, is currently -0.1 percentage point, which is well below the 0.5 percentage-point trigger of being in a recession.
Based on my years of working with surveys of consumers, I suspect much of the gloom now is related to gasoline prices. As they climb further, people will get gloomier.