WASHINGTON (AP) — The U.S. economy has contracted for two straight quarters, heightening fears that the country is on the verge of a recession — if not already in one — just two years after the pandemic recession officially ended.
Six months of contraction is a long-standing informal definition of a recession. Yet nothing is simple in the post-pandemic economy. His leadership has baffled Federal Reserve policymakers and many private economists since growth came to a screeching halt in March 2020 when COVID-19 hit and 20 million Americans were suddenly laid off.
Even as the economy contracted in the first half of this year, employers added 2.7 million jobs – more than in most entire years before the pandemic hit. And the jobless rate fell to 3.6%, nearly a half-century low. Robust hiring and extremely low unemployment are not compatible with a recession.
While most economists – and Fed Chairman Jerome Powell – have said they don’t believe the economy is in recession, many increasingly expect an economic downturn to begin more later this year or next.
Either way, with inflation raging at its highest level in four decades, Americans’ purchasing power is eroding. The pain is felt disproportionately by low-income households and Black and Hispanic households, many of whom struggle to afford more expensive essentials like food, gas and rent. Compounding these pressures, the Fed is raising interest rates at the fastest pace since the early 1980s, increasing borrowing costs for homes and cars and credit card purchases.
So how do we know exactly when an economy is in recession? Here are some answers to these questions:
WHO DECIDES WHEN A RECESSION HAS STARTED?
Recessions are officially declared by the obscure National Bureau of Economic Research, a group of economists whose Business Cycle Dating Committee defines a recession as “a significant decline in economic activity that spreads across the economy and lasts more than a few months”.
The committee views hiring trends as a key metric in determining recessions. It also assesses many other data points, including indicators of income, employment, inflation-adjusted spending, retail sales, and industrial production. It places great emphasis on jobs and an inflation-adjusted income gauge that excludes government support payments such as Social Security.
Yet the NBER typically doesn’t declare a recession until well after it begins, sometimes up to a year. Economists consider a half-point rise in the unemployment rate, averaged over several months, to be the historically most reliable sign of a slowdown.
DO TWO CONSECUTIVE QUARTERS OF ECONOMIC CONTRACTION EQUAL TO A RECESSION?
It’s a general rule, but it’s not an official definition.
Yet in the past it has been a useful measure. Michael Strain, an economist at the American Enterprise Institute, right, notes that each of the last 10 times the economy has shrunk for two consecutive quarters, a recession has resulted.
Yet even Strain isn’t sure we’re in a recession now. Like many economists, he notes that the underlying drivers of the economy – consumer spending, business investment, home purchases – all rose in the first quarter.
Overall gross domestic product – the country’s broadest measure of output – fell at an annual rate of 1.6% from January to March due to one-off factors, including a sharp increase in imports and a drop in inventories of businesses after the holidays. Many economists expect that when GDP is revised later this year, the first quarter may even turn out positive.
“The basic story is that the economy is growing but still slowing, and that slowdown really accelerated in the second quarter,” Strain said.
DO MANY PEOPLE THINK A RECESSION IS COMING?
Yes, because many people now feel more financially burdened. With wage gains below inflation for most people, rising prices for essentials such as gas, food and rent have eroded Americans’ purchasing power,
This week, Walmart reported that rising gas and food prices forced its shoppers to cut back on purchases of discretionary spending such as new clothes, a clear sign that consumer spending, a key driver of the economy, weaken. The nation’s largest retailer, Walmart, cut its profit outlook and said it will have to cut more items like furniture and electronics.
And the Fed’s rate hikes caused average mortgage rates to double from a year ago to 5.5%, causing a sharp drop in home sales and construction.
Higher rates will also likely weigh on companies’ willingness to invest in new buildings, machinery and other equipment. If companies reduce spending and investment, they will also start to slow down hiring. The growing caution of companies to spend freely could eventually lead to layoffs. If the economy were to lose jobs and the public grew increasingly fearful, consumers would cut spending further.
The Fed’s rapid rate hikes have raised the likelihood of a recession in the next two years to nearly 50%, Goldman Sachs economists said. And Bank of America economists now forecast a “mild” recession later this year, while Deutsche Bank expects a recession early next year.
WHAT ARE SOME SIGNS OF AN IMPENDING RECESSION?
According to economists, the clearest signal that a recession is underway would be a steady increase in job losses and rising unemployment. In the past, an increase in the unemployment rate of three tenths of a percentage point, averaged over the previous three months, meant that a recession would soon follow.
Many economists monitor the number of people filing for unemployment benefits each week, which indicates whether the layoffs are getting worse. Weekly jobless claims, averaged over the past four weeks, have risen for eight straight weeks to nearly 250,000, the highest level since last November. Although this is a potentially concerning sign, it is still an all-time low.
OTHER SIGNALS TO WATCH?
Many economists also watch changes in interest payments, or yields, on different bonds for a signal of recession known as an “inverted yield curve.” This happens when the yield on the 10-year Treasury falls below the yield on a short-term Treasury, such as the 3-month Treasury bill. It’s unusual. Normally, longer-term bonds offer investors a higher return in exchange for tying up their money for a longer period.
Inverted yield curves usually mean investors are anticipating a recession that will force the Fed to cut rates. Inverted curves often predate recessions. Yet, it can take 18-24 months for a downturn to occur after the yield curve inverts.
Over the past two weeks, the two-year Treasury yield has risen above the 10-year yield, suggesting that markets are expecting a recession to come. Many analysts say, however, that comparing the 3-month yield to the 10-year yield has a better record when it comes to predicting recession. These rates are not reversed now.
WILL THE FED KEEP HIKING RATES EVEN IF THE ECONOMY SLOWS?
Flashing signals from the economy – slowing growth with strong hiring – put the Fed in a difficult situation. Chairman Jerome Powell is aiming for a “soft landing,” in which the economy weakens enough to slow hiring and wage growth without causing a recession and bringing inflation back to the Fed’s 2% target.
But Powell acknowledged that such a result has become more difficult to achieve. Russia’s invasion of Ukraine and China’s COVID-19 lockdowns have driven up prices for energy foods and many US-made parts
Powell also indicated that if necessary, the Fed will continue to raise rates even in a weak economy if that is what is needed to get inflation under control.
“Is there a risk we’re going too far?” Powell asked last month. The biggest mistake to make… would be not to restore price stability.
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