As the country continues to struggle with high inflation, many Americans fear a recession. The Den spoke to two Mercer University economists about what a recession is, how we got here, and what we can do about it.
Dr. Antonio Saravia is associate professor of economics and director of Mercer’s Center for the Study of Economics and Liberty. With over 20 years of academic and consulting experience, his research focuses on institutional economics, political economy and the determinants of economic freedom.
Dr. Andres Marroquin is Associate Professor of Economics and Affiliate Professor at the Center for the Study of Economics and Freedom. With more than 15 years of experience in economics, his research focuses on culture, institutions, entrepreneurship and development.
What is a recession?
A recession is a significant slowdown in economic activity that results in lower gross domestic product, or GDP, growth. GDP is the monetary value of all final goods and services produced in a country.
“The conventional definition is that if you have two consecutive quarters of negative GDP growth, then you’re most likely in a recession,” Dr Saravia said.
Some economists debate how many consecutive periods of declining growth there should be, and others say additional indicators, like unemployment, impact whether a country is in recession, the report said. Dr. Marroquin.
So, are we in a recession?
Dr Saravia pointed to the Bureau of Economic Analysis’ recent GDP report, which shows the US economy shrank 0.9% in the second quarter of 2022, following a 1.6% decline in the first quarter.
“(We have) two consecutive quarters of negative growth rates, and every time that has happened, since at least the 1940s, the National Bureau of Economic Research has declared that period a recession,” Dr. Saravia.
The nonprofit National Bureau of Economic Research officially decides whether the US economy is in recession, but it has yet to make that call.
“Some people say yes because we see a reduction in GDP. Others say you have to be a bit careful because there are other indicators that are not as bad or could be worse, such as unemployment,” said Dr Marroquin. “The problem is that unemployment generally lags, which means that in a recession it takes time for people to start losing their jobs.”
So far, the United States has not seen the unemployment rate increase, which is expected during a recession. The United States added 528,000 jobs in July and, at 3.5%, the unemployment rate returned to its pre-pandemic level, according to the Bureau of Labor Statistics.
“If there is a recession, then we are going to see unemployment rise in the next few weeks or months,” Dr Marroquin said. “So we see a reduction in the rate of change in GDP, and then we might see an increase in unemployment.”
Dr Saravia said the job market is strong because workers are “cheap” right now. This is because nominal wages have not risen with the rate of inflation, he said.
“But at some point nominal wages are going to go up because workers are going to say, ‘This doesn’t make sense. I take home less money in real terms. You need to raise my salary. And when that happens, companies are likely to let people go,” Dr Saravia said.
“So the labor market is strong at the moment, but when nominal wages adjust to be in line with inflation, that’s when we’re going to start to see unemployment, and that’s very , very typical in a recession.”
Even though we are not in a recession yet, there is probably one coming.
“I guess things aren’t going well for the next few months because of what’s going on with interest rates,” Dr. Marroquin said.
In an effort to curb inflation, the Federal Reserve raised its benchmark interest rate. This contributes to inflation by taking money out of the economy, but at the same time makes it more difficult to obtain capital for economic development.
And a decrease in the growth of the economy leads to a recession.
How did we come here?
Flash back to 2020, when the COVID-19 pandemic had just taken hold. Many people lost their jobs or were out of work due to mandatory closures or illness.
To help ease financial stress on Americans from COVID-19, the federal government issued three direct payments, called stimulus checks, to individuals totaling $931 billion between April 2020 and December 2021. The Fed has also lowered interest rates.
This massive influx of cash into the economy directly contributed to inflation, Dr Saravia and Dr Marroquin said.
“What we’re seeing right now is a consequence of the COVID crisis that we’ve been dealing with but also the reaction of the Federal Reserve to this crisis,” he said. “In economics, any policy is going to have consequences, so what we’re seeing right now is a consequence of those policies.”
In June, inflation hit a 40-year high of 9.1%. In July, the inflation rate fell to 8.5%.
“Ultimately the culprit is inflation. We’re in a period of very high inflation the likes of which we haven’t seen in 40 years, and so the Federal Reserve, the central bank of this country, is trying to stop it,” Dr. Saravia said. “The only way to stop it is to act like a vacuum cleaner and suck the money out of the economy because the excessive amount of money is what drives up the costs.
“We have to remember that the money supply has grown at a very rapid rate since February 2020. In February 2021, the money supply was growing at a rate of 27% year-over-year. It was crazy. This variable normally increases at a rate of 3%. No wonder we have inflation. The only way to stop it is to reverse the process.
To stop inflation, the Fed must raise the interest rate, he said, which will make borrowing more expensive and therefore lower economic growth.
So far, the Fed has twice raised the interest rate by 0.75 percentage points, bringing the benchmark rate to a range of 2.25-2.5%.
Dr Saravia said the Fed’s reaction has been too tentative and more aggressive increases will be needed to fight inflation.
“You don’t like to think of a recession, but that’s what we need today. We need a recession because it is better to have a recession today than to have a recession later,” he said. “It’s like a snowball. If we don’t really step on the brakes to control inflation, the situation will only get worse. And the moment we decide to deal with the problem, we will have to raise rates even more drastically and create a much deeper recession.
“So what you want today is a hopefully mild recession that allows you to control the inflationary problem rather than having to wait and create a snowball of inflation that you don’t can’t stop.”
Dr. Marroquin said the Fed has a complicated job. He wants to control inflation while avoiding a recession. The government could take other measures to promote economic growth, such as reducing taxes and regulations to try to stimulate the economy.
“I think they are considering both of these scenarios. They might try to find a middle ground where they raise rates but not too much, so there is a possibility of a recession but it’s not as difficult,” he said.
How can I prepare my finances for a recession?
During a recession, borrowing money is more expensive and people can lose their jobs.
Dr. Saravia and Dr. Marroquin advised Americans to start saving and cutting spending now.
“Savings are going to be very important, and try to reduce your expenses,” Dr. Marroquin said. “Try to see if you really need what you want to buy, or can it wait? If you don’t really need it, you should probably wait and save that money because there’s a risk that a person loses his job.
“Try to be as prepared as possible for this, and that means having some savings you can use.”
Dr Saravia advised against buying anything that involves getting a loan, such as a car or a house, due to rising interest rates. If you need to get a loan, don’t get one with flexible rates.
“You can start with a bit low interest rate today, but if it’s a flexible interest rate, it’s going to go up as the Fed raises its benchmark rate – and the Fed will raise its benchmark rate more and more if it has to,” he said. “It’s the only way to stop inflation.”
He gave a word to consider when consolidating your finances: caution.
“Protecting yourself and your finances today, rather than borrowing and spending like politicians often want you to do, is what benefits the economy in the long run,” he said.