There has been much talk in recent days that the United States has entered into a recession. By one widely employed definition, a recession consists of two or more consecutive quarters of decline in a country’s real gross domestic product (GDP). By that definition, the U.S. officially entered a recession with the contraction of the GDP in both the first and the second quarters of 2022.
RELATED: ‘We’re Clearly in A Recession—By the Old Definition:’ Charles Goyette
It is fair to say, (a) the U.S. is now in a recession and (b) we do not know how deep or protracted it will be. Indeed, there is evidence that it may be brief. The third quarter of GDP may show an increase in real GDP, which will officially end this recession, even if the Wikipedia edit war over the term is destined to continue.
That said: it is important to note that the argument over this recession isn’t about a word. It is about a reality, or rather, about a nest of realities in people’s lives. It is about jobs, wages, salary increases, entrepreneurial opportunities, and the possible absence of all of those. The reason to care about a recession, or whatever we wish to call a downward turn in an economic cycle, is precisely that it hurts.
Consider jobs. In early August, President Joe Biden bragged that the jobs numbers were good. Mark Zandi, the chief economist at Moody’s Analytics, said, “There hasn’t been much of any slowing in the job market. This should dash any concern that the economy is already in recession.”
That is, frankly, economically illiterate. Higher unemployment numbers have never predicted an oncoming recession. They are not a leading but a lagging indicator. In other words, a recession predicts that unemployment numbers will soon turn up. So the fact of GDP shrinkage should have us worried about jobs. The fact that jobs, as of two weeks ago, were still holding up should not really reassure us about…anything at all. A look at what actually happens in a recession will make this clear.
How Do Recessions Happen?
Five things need to happen in order for a recession to occur:
- A decline in real income
- A decline in real GDP
- A rise in unemployment
- A drop in consumer spending
- Stagnation of industrial production and retail sales
The National Bureau of Economic Research (NBER) is in charge of making the official call on whether the U.S. is in a recession.
NBER tracks numerous economic indicators, including those listed above, when determining when to waive the recession flag.
The Stages of the Business Cycle
A recession is part of the business cycle, which is a cycle of fluctuations in the GDP around its long-term natural growth rate. It explains the expansions and contractions of economic activity.
The stages are:
1.) Expansion: Economic indicators, such as employment, income, output, wages, profits, demand, and the supply of goods and services, increase. People are paying their debts on time, the velocity of the money supply is high, and investment is high.
2.) Peak: This occurs when the economy reaches a saturation point. Growth hits its maximum rate, economic indicators do not grow further, and prices are at their highest.
3.) Recession: This follows the peak stage. In this stage, the demand for goods and services declines, producers oversupply, prices fall, and economic indicators (income output, wages, etc.) fall.
4.) Depression: Unemployment rises, and the growth of the economy continues to decline below the growth line.
5.) Trough: The economy’s growth rate becomes negative. This decline continues until the prices of factors and the demand and supply of goods and services reach their lowest point. This is the negative saturation point for an economy. National income and expenditure deplete extensively.
6.) Recovery: The economy begins to turn around and starts to recover from the negative growth rate. Demand increases due to low prices, which causes the supply to increase.
The Mechanics of a Recession
Let us take the economy into a garage and get under the hood. What exactly happens when a nation’s economy goes into negative real growth? First, activity—the firing of the gears of our economic engine, at its core, buying and selling—slows down. Fewer consumers are buying at the shops. The shops are doing less buying from their wholesalers. The wholesalers, in turn, are doing less buying from their manufacturers.
Why? For some recessions, the answer is simply: “because there was too much activity before.” Bubbles burst. Overly hot engines cool down.
Sometimes the answer is more complicated. A slowdown may be triggered by pandemics, wars, interruptions in the markets for critical fuels, and much more.
Once a general slowdown happens, though, there is predictably a loss in stock values. The public indices (the Dow, the S&P, etc.) head downward. This creates anxiety and undermines the retirement plans of some of the people who had been holding those stocks.
Given this anxiety, about the slowdown, about stock market losses, or both, households start pulling together their cash. They put more money away in savings accounts (or at-home safe boxes), and they sometimes sell their assets (an extra car). Households engage in what is sometimes called “hoarding.” That is an unlovely term, but it is a natural reaction to the facts in people’s lives or what they hear about in the news: akin to piling up firewood in the autumn.
The Monetary Tools Stop Working
One of the consequences of this savings impulse is that some of the usual tools in the central bank’s toolbox no longer work. Central bankers think, “Ah, we can turn the economy around by increasing the monetary base.” But at this stage in the business cycle, that doesn’t work. Consumers won’t spend the money when they can sock it away, and lower interest rates won’t tempt them to borrow. Central bankers often, cycle after cycle, express their frustration with this phase with a single expression. “We can’t push on a string.”
This is where those job losses typically kick in. Businesses save by cutting operations, and the people who used to do the work for those operations become superfluous.
As the song says, “Once I built a railroad, made it run. Made it race against time. Once I built a railroad, now it’s done. Brother can you spare a dime.” Except that the railroad may not be “done” at all. It may be simply that the corporation financing the laying of the rails decides it can’t afford to finish that line, and the trains will have to continue their races against time on the older tracks.
Volatility is the Rule, not the Exception
In due course, every recession in history has reversed. The mechanics of recovery is a large subject, but the “animal spirits” do reassert themselves, and activity resumes. At the bottom of the business cycle, there are values to be found: productive assets that aren’t being used. Someone will buy them at a bargain price and put them to work. This will, in time, mean a scaling up of operations, new hires, and so forth.
Volatility, though, has become the rule, not the exception. It plays havoc with planning. After all, the boom/bust cycle is predictable in broad terms but never in its particulars. Which industries will be destroyed by the next recession, which might merely be trimmed, or they might ride it out nearly unscathed: these things are seldom predictable.
Even medium-term planning, for just the next year or two, can be a dismaying matter of guesswork, even for the fortunate.
For the less fortunate, during even moderate recessions, there will be people trying to get by from one unemployment check to the next, deciding to make their landlord wait because they have to pay the phone bill immediately, or vice versa.
The chaotic nature of the contemporary financial system bears a large share of the responsibility for this state of affairs: for the volatility, the GDP declines, the lay-offs, the psychological and physical harm even to those who retain their jobs. At the base of much of it is the fact that the supply of money is a product of policy makers’ whims.
About the Author
