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How the U.S. Economy Could Slip Into a Recession

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Milton Ezrati

Recent economic news signals strength, at least on the surface. Retail sales for the last few months have surpassed expectations and outpaced inflation. Mainly because of the strong consumer, the nation’s recently released gross domestic product (GDP) showed a robust annual real growth rate of 4.9 percent for the summer quarter. This news has changed opinions among economists. According to the Wall Street Journal, the consensus of economists has dismissed the once widely-held expectation of recession. Given the poor forecasting record of consensus thought, this shift of opinion should, at the very least, raise red warning flags. Indeed, behind the bright headlines, the economic landscape warns against a too-glib dismissal of future financial trouble.

Federal Reserve (Fed) policy constitutes one bit of that worrisome economic typography. Monetary policymakers show no sign of relenting in their anti-inflation efforts. They may pause in raising interest rates further than they already have, but they have indicated that there still may be rate hikes in the future, and at the very least, they will keep rates elevated until they are sure that inflationary pressures have firmly returned to the Fed’s preferred rate of 2 percent a year. That is a long way from where things are today. If that were not enough to give optimists pause, policymakers have no doubt noted how GDP inflation actually accelerated during the third quarter to a 3.5 percent annual rate, up from an otherwise comforting 1.7 percent in the spring quarter. The seeming recent economic strength might also embolden the Fed’s inflation-fighting efforts by offering policymakers security against recession. While such Fed responses do not guarantee recession, they certainly give no reason to look for ongoing economic strength.

Nor is there a reason for much economic optimism in the ongoing slow pace of new capital spending. The recent GDP report that has otherwise lifted spirits in the economics community also included news of an actual decline in capital spending by American businesses and industries. The whole sector showed only a tiny drop of 0.1 percent at an annual rate, but it is particularly worrisome that spending on new equipment fell at a 3.8 percent annual rate. This extends the average 1.3 percent real drop of the past four quarters. Since much of the technology industry and business applies is embodied in the new equipment it buys, this shortfall says nothing good about the nation’s developing productive capacity or productivity growth. Nor does it help that direct spending on technology—what the Commerce Department calls “intellectual property products”—has slowed dramatically over the past three quarters.

Moreover, there is good reason in the mix of consumer spending to doubt the durability of the consumer “splurge” at the root of all the good news. The Commerce Department notes that the bulk of recent spending came from outlays on durable goods, things like cars, and household appliances. Spending in this area jumped at a remarkable 7.6 percent annual rate in the third quarter, far surpassing a little over 3 percent growth in spending on nondurable goods and services. Since these sorts of goods last for a while, surges in spending on them are almost always followed by a spending ebb. This expectation of a coming ebb receives reinforcement from households’ typical response to inflation. When prices are rising quickly—and they continue to do so even if not as fast as a year or so ago—households will buy sooner than they otherwise might to get ahead of expected price increases. Goods that last over time—durables—are especially attractive in this inflation-beating game. But again, because the stuff people buy lasts, the surge from this motivation, as well, is usually followed by an ebb.

Continued strong consumer spending also seems vulnerable to the deteriorating state of household finances. Inflation, according to all indicators, has outstripped household income growth for three years running. Real household income, according to the Commerce Department, has actually declined over the past two years. Yet real spending has held up, especially in recent months. Consumers have managed this trick by cutting back on flows into savings they might otherwise have made. Those flows have dropped from 8.5 percent of after-tax income in the third quarter of 2021 to barely 3.8 percent in this year’s third quarter. Households could squeeze savings even more. They have saved at lower rates in the past. But there is clearly a limit at which point the “splurging” will have to stop. And it is not very far away.

Presently, thoughts of recession have receded under a tremendous flow of good economic headlines. Those headlines, however, do not tell the whole story, which is not nearly so sunny. It would be a mistake to dismiss the prospect of economic trouble sometime soon—even recession.

Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and chief economist for Vested, the New York-based communications firm.