The news is filled with stories of when to expect the next recession. Most say that it will not be this year, but almost certainly sometime in the next two or three years. The underlying assumption is that the current expansion, which will surpass our nation’s longest expansion of the 1990s this summer, has to end soon.
But there is not a “natural” economic reason for this expansion to end. A look back shows recessions occurring from time to time. In recent decades they have been less frequent and have been much milder and shorter than historically, other than the 2008 Great Recession. The onset of a recession can generally be traced to some combination of fiscal and monetary mistakes. The one recent exception was the 2000-’01 recession resulting from the large overvaluations built up during the 1990s.
Forecasting the next recession is not a mechanical “business cycle” process but involves trying to figure out when the next major policy mistake will be made. Without such a mistake, the expansion could continue uninterrupted into the foreseeable future.
The counter argument is that if fiscal and monetary authorities are given enough time, they will mess up. There is some truth to this. The tin ear response of Federal Reserve Chair Jerome Powell to market and economic conditions in December last year is a reminder of how such monetary mistakes can arise. But bond and stock markets reacted strongly, the Fed retreated quickly, and a potential mistake was avoided.
Economy Less Susceptible to Downturns
The good news is that the economy has become less susceptible to downturns and policymakers have become more adroit at setting the stage for growth and low inflation.
It used to be that the severity of a recession was driven by how much inventory had to be drawn down. Inventories build up as sales slow, while production continues. The steeper the sales drop-off, the greater the inventory buildup, and the deeper and longer the recession, as firms cut back on production. But in recent years, industry has widely adopted just-in-time inventory management and thus are able to respond much more quickly to changes in demand. And advances in technology have made this process even more responsive.
One of the great surprises in recent years is how tame inflation has remained as the economy strengthens. The U.S. is experiencing a full-employment unemployment rate of 3.6%, accompanied by GDP and wage growth exceeding 3%. Historically such conditions have produced surging inflation. But that has not happened this time around.
It still remains to be seen if this is a temporary phenomenon or if inflation will heat up in the near future. We have been waiting for this uptick for some time, with no increase in sight. The longer tame inflation continues, the more likely it is that the Phillips Curve, which posits an inverse relationship between unemployment and inflation, becomes a theory of the past.