“Is the US economy heading towards recession? In this article, we examine the most recent economic data and analysis to provide a comprehensive overview of the current state of the US economy and explore whether or not the United States will experience a recession”
Is The US Economy Heading Towards Recession?
Many economists and studies state that “the US economy may face recession in 2023”. The main reason for this is a result of the Federal Reserve’s continuous rate hikes (many feel like a massive hike). According to a December Bloomberg survey, “Economists say there is a 7-in-10 chance that the US economy will enter a recession next year, slashing demand forecasts and trimming inflation projections in the aftermath of the Federal Reserve’s massive interest-rate hikes.” This probability has climbed from 65% in November, to 70% in December 2022. This survey was conducted between 12th December and 16th December 2022, with 38 economists.
The apprehension of many economists is due to seven straight hikes in the Federal Fund Rate and putting it into a range of 4.25% to 4.5% from near zero in March 2022.
Is Inflation in the U.S. still Interest Sensitive?
In 2015, Jonathan L. Willis (Vice President and Economist) and Guangye Cao (then research associate), Federal Reserve Bank of Kansas City, did a research study on this topic and published a paper titled “Has the U.S. Economy Become Less Interest Rate Sensitive?”
According to the study, the US economy has become less sensitive to and responsive to monetary policy over the last three decades. Slow recoveries followed the recession in 1900-91, 2001 and 2007-09. This is in contrast to the much rapid recovery which happened before the 1990 (pre-1990) recession. It also states that these slow recoveries occurred despite substantial monetary accommodation by the Federal Reserve mainly by reducing their short-term interest rates.
According to their findings, the economy’s interest rate sensitivity is decreasing. In their own words they stated that “Overall, the findings suggest the decline in the economy’s interest sensitivity is not due to changes in the conduct of monetary policy but rather to structural changes in industries and financial markets.” As a result, it is clear that the economy is less interest-sensitive than before due to structural changes in industries and financial markets.
Money Supply and Inflation:
The officials of the Federal Open Market Committee (FOMC), have signalled in their statement that they could pause the rate hikes for several months in 2023. They also stated that keeping a higher interest rate or more appetite for a peak interest rate would constrain economic growth.
In the first place, we need to understand what caused these rate hikes. Many may be aware that Inflation in the USA has reached 9.0% in June 2022. To control inflation from such a height it was essential for FOMC to hike interest rates. Eventually, due to these hikes inflation dropped to 7.1% in November 2022.
It has to be noted that the Money Supply (measured in terms of M2) grew from almost $ 14 trillion in 2018 to $ 21.74 trillion in March 2022 (see graph below).
This gradually came down to $21.35 trillion in November 2022 (where inflation also came down to 7%). This shows why inflation was higher during the first half of 2022 and how it is gradually coming down. In other words, the increase in money supply leads to an increase in inflation in 2022 and the slowdown in the rate of inflation today is also due to the contraction of the money supply.
GDP – Slow Growth
Now let us look at how the GDP is for the past five years (i.e. from 2018 to 2022) quarter on quarter. In the third quarter of 2022, the Real Gross Domestic Product (GDP) (seasonally adjusted – from third estimates data) increased at an annual rate of 3.2%. According to the data, the increase in real GDP can be attributed to increases in exports, consumer spending, nonresidential fixed investment, state and local government spending, and federal government spending. On the other hand, the Residential fixed investment and private inventory investment has decreased.
So from the third estimate data, it is clear that the economy is moving slowly towards more growth and there is no sign of recession. There is only a sign of slow or low growth in the economy. Then why do many economists feel recession may hit the U.S. in 2023, let us find out the same.
Reasons for Expectation of Recessions:
As we have seen early that the apprehension of many economists is due to seven straight hikes in the Federal Fund Rate. This is one of the massive hike rates since the 1980s. Other than this Russian-Ukraine war, is one of the major concerns. The Russian invasion of Ukraine is making things very difficult for US exporters. Other than this there are other short-term challenges like a higher dollar, lower global demand for US products (esp. from Europe) etc. Another important factor which is slowing the US economy is the supply chain problem.
Addressing Basic Economic Parameters – Need of the hour
As the pandemic is slowly waning across the world the supply chain problem that the US was facing is now slowly fading out. Once this supply chain comes to normal then the economy will rebound to its pre-pandemic level.
The investment and financial conditions have to improve in the economy. It is however expected that financial conditions for the US as well as across the world may normalise and would create more investment opportunities outside the US. This will make less desire to hold dollars to avoid risk factors which will eventually lower the dollar and make the US more competitive across the world. The recovery of the global economy from the pandemic will eventually increase the demand for US goods.
Other than these, the basic economic parameters which the US have to addresses are:
- Fiscal Deficit – The US government has to find ways to reduce its fiscal deficit along with its borrowings. Otherwise, this may be a problem for recession too.
- Inflation – Though Inflation is slowing down, it is important that the US should not only be vigilant about it but should also be careful about handling the hike of interest rates.
- Labour Market – The slow growth rate may lead to more unemployment as there will be less hiring. How the economy is going to respond and how the US government is going to handle this problem is more important.
These are challenges for the US, which have to be addressed as they are the need of the hour. This year the US may be walking on a tightrope, but it has to walk slowly to survive else the economy may fall into recession.
FAQ
What is a recession?
A recession is a period of economic decline, characterized by a decrease in Gross Domestic Product (GDP) for at least two consecutive quarters. It is typically defined as a significant decline in economic activity spread across the economy, that lasts more than a few months.
What are the indicators of an impending recession?
Indicators of an impending recession include rising unemployment, decreasing consumer spending & a decline in housing prices. Economic indicators such as Gross Domestic Product (GDP), industrial production, and consumer confidence also provide insight into the state of the economy.
What industries are most affected during a recession?
During a recession, industries such as manufacturing, construction, & retail tend to be most affected. As consumer spending decreases, companies in these industries often encounter a decrease in revenue & may need to cut jobs.
How does the stock market react to the possibility of a recession?
The stock market may react negatively to the possibility of a recession due to investors becoming more risk-averse & selling stocks. However, it should be understood that a recession does not always imply a stock market crash.
How can individuals prepare for a potential recession?
Individuals can prepare for a potential recession by building an emergency savings fund, paying off debt & diversifying their investments. They can also consider learning new skills or starting a side business to increase their chances of staying employed during a recession.