Economists and Wall Street warn of a possible recession. How worried should you be?
Economists and Wall Street continue to warn of a possible recession. But the economy is in very different shape compared to the Great Recession over a decade ago.
Recession fears are rampant. No matter where you get news, you’re bombarded by recession calls from investors and economists.
It is prudent to be nervous about a recession — a broad and persistent decline in economic activity — hitting in the next year or two. The reason is skyrocketing inflation, which forced the Federal Reserve to promise quick interest rate increases. Rising rates have brought many past economic expansions to an end.
But recession is not inevitable, nor is it the most likely path. The Fed’s aggressive actions have worked, at least so far. Inflation expectations have fallen and are consistent with inflation soon receding. And it will retreat — if the pandemic continues to fade and the worst of the economic fallout from the Russian aggression is behind us. These are optimistic expectations, to be sure, but they are reasonable.
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Moreover, none of the problems that typically plague the economy and cause or contribute to a downturn are evident. What is most obvious is that American families are devoting the smallest share of their income to making interest and principal payments in more than 40 years. They did a yeoman’s job of locking in record-low interest rates by refinancing their mortgages when they had the chance.
Also, most families saved much more during the pandemic than they typically would. High-income households were forced to shelter in place and couldn’t spend on travel, restaurants, and ball games. Lower-income households received generous financial support from the federal government through stimulus checks, enhanced unemployment insurance, rental assistance, and other help.
This is much different from the period before the Great Recession more than a decade ago. Then, households struggled with record-heavy debt burdens and had little savings. During that downturn, homeowners were crushed when house prices collapsed amid a vastly overbuilt housing market — mortgage lenders had provided unaffordable loans to millions who lost their homes.
The current red-hot housing market will cool off, and some house price declines are likely. But with housing in extraordinarily short supply and lending pristine since the housing crash, house prices seem set to retrace only a bit of their recent boom-like gains.
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Businesses are also in great financial shape since they have never been so profitable. Corporate debt burdens are as light as they’ve been in a half-century. Most businesses have been judicious borrowers and were adept at locking in record-low interest rates when they could. Bigger businesses are in a better financial position than smaller companies. But in aggregate, American businesses have rarely been on stronger financial ground.
This hasn’t precluded the stock market from taking it on the chin of late. Investors rightly believe that businesses can’t maintain such high profitability. But the market declines follow a long run-up for most stock prices. Even with the current sell-off, investors have enjoyed double-digit per annum returns over the last decade. And it is important to remember that the stock market is apt to go up, down, and all around. The recent slide is still not extraordinary.
Perhaps most encouraging, the nation’s financial system has arguably never been stronger. Banks are awash in capital — funds they need to set aside to cover any losses on the loans and other investments they make. During the Great Recession, banks blew through their capital and required a bailout from the federal government to avoid failing. Failure would have meant the credit that households need to buy homes and cars and that businesses need to hire and invest would have dried up. The economy would have sunk even further.
None of this seems remotely possible today. There are few scenarios in which financial institutions would curtail providing credit, and as long as credit continues to flow, recession is less likely.
Recession calls are sure to get louder as the Fed continues working to rein in inflation and politicians running in the midterms portray the economy’s struggles to their advantage. Ignoring the calls isn’t advisable, but given the economy’s strong fundamentals, buying into those calls isn’t recommended, either.
Mark Zandi is chief economist for Moody Analytics.