There's a Recession Coming

Consider the source. Whatever interpretation you wish to attach to it, I find it a good thing when former Obama administration officials break with the Biden administration on the economic outlook.

Lawrence Summers, now famously, declared last year that we would be suffering from a bout of inflation. People dismissed his opinion, and some still do. But, he seems to have been prescient, on the one hand, and on the other, he was demonstrating integrity.

Breaking with the party line takes courage, so we applaud it. We have never, on this blog, proposed that we should all live in an echo chamber.

Now, another former Obama administration official, a Democratic financial guru, by name of Steven Rattner has offered his views of the current state of the economy, in the New York Times.

He opens by addressing the Biden administration talking point, to the effect that the current bout of inflation is transitory. And he adds his view about whether the Federal Reserve can tamp down inflation without producing a recession. He says that it cannot.

The debate over whether the recent surge in inflation is transitory or permanent has been settled. Now the question is whether the Federal Reserve can tame increasing inflationary turbulence and bring the economy to a soft touchdown.

Mounting evidence suggests a hard landing — in other words, a recession. 

How could we go about reducing inflation. Rattner says that we need to convince people to spend less. If they do, the economy will slow, jobs will disappear and production will slow down.

Let’s go back to Economics 101. Our inflation problem stems from too much demand relative to available supply. Increasing supply is invariably a slow process.

To reduce inflation — and this is the part that’s rarely said aloud — we must reduce demand. That means forcing Americans to spend less. Which in turn leads to fewer jobs and slower wage growth, historically to the point where we tip into recession.

How did we get into this mess? Rattner places the blame clearly on the Federal Reserve and the Biden administration. A refreshing position coming from a Democrat:

That’s not desirable, but it is the price we pay for poor economic policies delivered by the White House, by Congress and by the Federal Reserve. Those poor policies include far too much budgetary stimulus as we addressed Covid challenges. The $1.9 trillion American Rescue Plan passed in the early days of the Biden administration will go down in history as an extraordinary policy mistake. And the Fed — an esteemed, independent steward of our monetary policy — similarly overestimated the amount of support the economy needed and pumped trillions of dollars into the system.

In truth, Summers had already named the Federal Reserve’s milquetoast approach the culprit here. Surely, when the Fed chairman read Summers he recognized that he had erred, and changed his tone. It does not give us very much confidence in the people who are running the Fed. But, at least it’s diverse. And besides, Powell is a lawyer, not a banker. What could go wrong?

Rattner suggests that the Fed will need to raise interest rates far higher than everyone is currently forecasting:

In the past, addressing an inflation problem necessitated the Fed raising interest rates above the inflation rate. Even using the Fed’s preferred inflation measure, which is now tracking at 6.4 percent, that would mean rates far higher than the Fed’s current prediction of 2.4 to 3.1 percent by the end of 2023.

Why does this matter? He explains:

Rising interest rates slow the economy in several ways. Higher rates make large purchases bought on credit, like homes and automobiles, less affordable, thereby reining in demand and cooling prices. For their part, businesses would borrow less. And the stock market would also be hit, as investors shifted capital to take advantage of more attractive interest yields on bonds.

Softer home values and a potentially declining stock market would trigger a reverse wealth effect: Feeling less well off, Americans would spend less. All of this would ripple through the economy, ultimately resulting in less economic activity.

As for the Biden administration’s approach, Rattner thinks that its either a lie or a fairy tale:

Optimists — including the Biden administration — argue that the current supply-demand imbalance can be addressed on the supply side of the equation. That is fantasy. Intel has, happily, announced plans for a new semiconductor plant in Ohio, but that facility won’t be operational until 2025. Nor will attacking oligopolistic practices in the meatpacking industry or the escalating cost of hearing aids have any measurable effect on overall prices.

So, he suggests that we are inevitably heading for a recession, produced by Biden administration incompetence and Federal Reserve incompetence. 

What can policymakers do to avert a recession? At this point, regrettably little. The best approach would be to begin tightening before expectations for future inflation become embedded. Among the most compelling lessons of the double-digit inflation of the late 1970s is that it is far more difficult to unwind an inflation problem than to forestall it.

And, on the fiscal side, less spending would encourage the markets and perhaps even consumers:

Those moves to unwind should include fiscal policy. Rather than increasing the near-term budget deficit, the White House should heed the advice of Senator Joe Manchin and couple new social programs — however meritorious — with an equal measure of deficit reduction.

Rattner suggests that the recession is not imminent, but that it will arrive in time for the 2024 presidential election campaign. If he is right, then the Democratic Party should be very very scared:

I don’t believe that a recession is imminent; there’s too much capital sloshing around in the system for that to be likely. The Harvard professor Jason Furman estimates that Americans still have $2.3 trillion above prepandemic trends stashed in their bank accounts, largely as a result of special government payments and underspending during the pandemic lockdowns.

The former Treasury secretary Lawrence H. Summers has observed that over the past 75 years, every time inflation exceeded 4 percent and unemployment was below 5 percent, a recession ensued within two years.

Bond markets also accurately predicted past slumps. When 10-year interest rates fall below two-year rates, recessions have, on average, occurred in about 18 months.

With both conditions having been true this month — at least briefly — that would suggest a downturn just as the 2024 presidential campaign season is getting underway. A potential electoral nightmare for Democrats to ponder.

Straightforward and honest, just what the doctor ordered.