As economywide spending slows, they receive fewer business and tourist bookings. This leads hotel rooms their key capital stock to sit empty, which in turn leads them to lay off cleaning staff. Ending a recession, therefore, requires replenishing aggregate demand.
Could Europe face the next recession?
The most specific causes of aggregate demand contractions, and resulting recessions, in the post—World War II period have been fiscal contractions often caused by military spending drawdowns , monetary policy tightening the Federal Reserve overshooting in attempts to fight inflation by raising interest rates too high , and popping asset market bubbles.
Below, we examine each of these past causes in turn, to consider whether any of these threaten to derail the expansion in coming years.
Luckily, there seems to be little danger that fiscal contraction will cause a recession in the near future. It is important to note that, contrary to claims made in fiscal policy discussions in , the boost provided by the increases to spending was clearly larger than the boost provided by the tax cuts. The tax cuts, while expensive in budgetary terms, were terribly designed for providing fiscal support because they provided so much of their benefit to higher-income households whose current spending is not constrained by income.
Nevertheless, the tax cuts and increased spending did provide a fiscal boost to the economy. But even with this clear recent evidence of the benefits of expansionary fiscal policy even poorly designed fiscal policy , the Trump administration continues to parrot evidence-free warnings about the danger of excess federal debt. This debt fearmongering is seen in their annual budget proposals, which call for draconian levels of austerity. Finally, much of the catastrophic fiscal drag that delayed full recovery from the Great Recession was actually imposed by state and local governments.
Hopefully, the swing in state government control away from Republicans in the last election will make another wave of state-led austerity less likely in the next few years. Excessively contractionary monetary policy is likely the single most common cause of recessions in the post—World War II period. Too often, however, the Fed has raised rates too far and too fast, and the result has been a recession. Too-rapid interest rate increases clearly played a role in the recessions of the s, s, and s.
The Fed made the earliest decisive policy decisions to support aggregate demand and was willing to undertake historically unprecedented actions to keep the recovery moving forward in the face of fiscal austerity. In , the signature of excessively rapid interest rate increases slowing economic growth was clear.
Next recession will hit during Trump’s first two years - MarketWatch
Residential investment contracted in each quarter in , the first time this has happened since The trade deficit also expanded and weighed on growth, with American exports and import-competing domestic producers hampered by a U. These two drags on growth—contraction of residential investment and a rising trade deficit—are exactly those predicted by those who worry that excessively fast interest rate increases will slow spending.
If the drag from more-contractionary monetary policy continues in with no offsetting new fiscal stimulus, the economy could certainly see a sharp slowdown in growth in the coming year. Given that Donald Trump has occasionally criticized recent interest rate hikes, should his administration be exempt from blame in terms of the harms of contractionary monetary policy? Not particularly. If the Fed had followed their advice, unemployment would be considerably higher today. Subsequent appointments after Quarles and Goodfriend—Richard Clarida and Michelle Bowman—have been better, but given that they have filled slots previously held by governors with dovish views on monetary policy, they have not moved the center of gravity on the BOG in a more dovish direction.
To be sure, Yellen undertook some rate increases that may have been unwarranted. But she also resisted repeated calls to do the wrong thing. Powell deserves much respect for his performance as a Fed BOG member and chair, but the shift from Yellen to Powell is almost surely one to a Fed less committed to expansionary policy in coming years. It also represents a transition to a Fed chair who does not have a strong track record of resisting calls to raise rates.
In recent weeks, the Fed has implicitly acknowledged that recent rate increases may have overshot, indicating strongly in the March meeting of the Federal Open Market Committee FOMC that they may go the rest of this year without raising rates again. Both criticized the Fed for being too dovish during the Obama administration. As detailed in an earlier section of this report, partisan Republican policymakers throttled recovery from the Great Recession with fiscal policy choices. If policymakers this partisan are allowed onto the Federal Reserve Board, we would see a repeat of this in future recoveries with monetary policy.
The last two American recessions were unambiguously caused by bursting asset market bubbles: the stock market bubble in and the housing price bubble after The clear lesson of these episodes is that policymakers must be vigilant about not letting bubbles inflate to dangerous proportions. Policymakers—particularly in the regulatory realm—have a number of tools available to keep asset markets from getting dangerously mispriced.
Janet Yellen did this in a single speech in about technology stocks and sparked a relatively strong downward response from prices. Regulators can also impose quantitative limits on how much debt is taken on to purchase assets. In the case of home prices, for example, the Federal Housing Administration can ratchet down loan-to-value ratios effectively requiring higher down payments from home buyers when consumers take out mortgages.
Finally, regulators can ensure that financial institutions are prudently managed and maintain sufficient capital buffers to guard against collapse in the face of small downward movements in asset prices. The housing price bubble bursting would have hurt less though it certainly would not have been painless if it had not cascaded through a financial sector whose individual institutions had recklessly loaded up on debt and threatened to topple over like dominoes in the face of the housing price shock. All approaches to stopping bubbles before they get large enough to harm the American economy have one thing in common: a rare willingness to pull the punch bowl away from powerful actors in the financial sector as the bubble inflates.
All of its nominees to Fed BOG positions are softer on financial regulation than the members who preceded them. Randal Quarles, a former Carlyle Group executive who occupies the post of vice chair for financial supervision at the board—is particularly soft on finance. For example, Quarles has opposed the Volcker Rule, a regulation that limits bank risk-taking with depositor money and is essentially already a compromise effort to restore some of the safety that the Glass Steagall Act provided the banking sector before it was repealed in Mulvaney, a long-time advocate of abolishing the CFPB while in Congress, has urged lobbyists to keep pressuring for a more compliant CFPB and wrote a memo to CFPB staff telling them that they work not just for consumers of financial products but for the providers of these products, too: banks.
At the moment, there is no glaring, macroeconomically significant asset market bubble that looks guaranteed to burst in coming years. Still, some markets are seeing prices on the high side of historical experience relative to fundamentals, and might require some stiff-backed supervision from financial regulators to avoid becoming a danger to the broader economy before too long.
On this front, it is unambiguously clear that the Trump administration is not up to this job and has left the U. Regardless of why or when the next recession hits, policymakers should use every effective tool at their disposal to end it as quickly as possible and pin the economy back at full employment. To be effective, these tools need to boost spending by households, businesses, or governments to relieve the aggregate demand shortfall that is the fundamental cause of recessions.
The traditional view of mainstream macroeconomics before the Great Recession was that monetary policy would be sufficient to end recessions quickly and that discretionary fiscal stabilization would be either unnecessary or outright harmful. A clear lesson from the Great Recession and its aftermath is that the conventional monetary policy response of lowering short-term interest rates—and even the unconventional response of buying long-term assets in order to lower long-term rates—will be insufficient to combat the next recession.
However, as weak as the mechanical effects of interest rate cuts are in spurring growth in spending, this does not mean the Federal Reserve should not cut rates as aggressively as possible during recessions. For one, even the weak direct effect of interest rate cuts at least moves the economy in the right direction. Fiscal policymakers, particularly in Congress, do not generally have huge staffs whose job is almost exclusively focused on monitoring the state of the macroeconomy, whereas the Federal Reserve does.
Further, this expertise, as well as its political independence, gives the Fed great influence in economic debates. This leads to fiscal policymakers often following the lead of the Fed when it comes to recession-fighting. But the Fed really should not be graded on the curve of their own often-opaque communications. The fiscal austerity that hamstrung recovery from the Great Recession was not simply the result of good-faith-but-sadly-mistaken efforts to genuinely assess what the economy needed. Rather, the pull toward fiscal austerity was largely rooted in partisan politics. In short, the Fed should be much louder in communicating with other policymakers when their judgment is that the economy needs more stimulus than monetary policy can provide.
One way to be loud is simply through more blunt communication. There has been much analysis about the efficacy of Fed communication with other economic decision-makers—so-called forward guidance—over the past decade. Forward guidance is simply providing clear communications and strong signals about the likely short-run trajectory of interest rates. But this forward guidance has always been narrowly focused on the likely path of monetary policy actions only. A more expansive view of the role of forward guidance would be useful in fighting the next recession.
Again, the Fed is the primary watchdog for macroeconomic instability. If they bark loudly about the need for fiscal policy support to end a recession or spur recovery more quickly, this would put a lot of pressure on other policymakers to act. Another way for the Fed to amplify the need for fiscal policy support for ending recessions and spurring recovery is to adopt even stronger unconventional monetary policy tools.
An alternative way of undertaking quantitative easing would be to pre-commit to the interest rate reduction the Fed was targeting, with the scale of asset purchases being open-ended. For example, the Fed could have said they were targeting a 2 percent nominal year Treasury interest rate and would buy as many bonds as needed to achieve this target. Any ambitious long-run interest rate target may well have required substantially larger asset purchases than the Fed actually undertook, but in terms of macroeconomic stabilization, this just means monetary policy would have been more expansionary overall—a good thing.
Beyond the mechanical boost from more expansionary monetary policy, a long-term interest rate target would have been a dramatic invitation to fiscal policymakers to do more, and could have encouraged them directly to do more by assuring them that long-term debt payments arising from more stimulus would be modest. The most direct way for policymakers to fill the aggregate demand gap that drives recessions is public spending. This was the case even as the ability of monetary policy to fight the recession to that point had been severely hamstrung by the zero lower bound on interest rates.
Figure B shows the cumulative growth in per capita spending by federal, state, and local governments over the business cycle following the troughs of the 11 recessions since World War II. Astoundingly, per capita government spending in the first quarter of —twenty-seven quarters into the recovery—was nearly 4.
By contrast, 27 quarters into the early s recovery, per capita government spending was 3. Notes: For total government spending, government consumption and investment expenditures are deflated with the NIPA price deflator. Government transfer payments are deflated with the price deflator for personal consumption expenditures. This figure includes state and local government spending. Source: EPI analysis of data from Tables 1. In turn, this pace of public spending growth would have seen the U. At the state and local level, slow growth of public spending is even more pronounced than at the federal level, and state and local policymakers certainly deserve much of the blame for the slow recovery.
Just one example of austere spending policies at the subfederal level is the decision by 19 states to refuse free fiscal stimulus from the Medicaid expansion under the Affordable Care Act. The reason for this is simple: State and local policymakers face spending constraints that do not apply to federal policymakers.
Most specifically, these state and local policymakers by and large have to balance the operating portions of their budgets by law. States do not print their own currency. This means that they really do have to be more cautious about running up debt that sometimes erratic financial markets can decide rightly or wrongly is unsustainable. In contrast, the federal government is free to run deficits.
And because it can print its own currency, it does not have to ratchet interest rates ever higher if private investors are unwilling to absorb new public debt for a spell of time. Even during normal times, transfers from the federal government to states account for more than 20 percent of total state and local resources for spending.
There is no reason, other than politics, that federal aid to states could not have been more forthcoming in the face of such historically high need. Even the timing of austerity over the current recovery is fairly easy to pinpoint in the actions of Republicans in Congress. The Obama administration championed and signed the American Recovery and Reinvestment Act ARRA during the recession in early , and the law led to a jump in government spending that persisted throughout the early stages of the recovery.
Through the end of when the ARRA had mostly petered out , total government spending per capita was not that different from spending during previous recoveries and actually rose more rapidly than in previous cycles during the recession phase. But in Republicans in the House of Representatives demanded spending cuts as a precondition for raising the debt ceiling, a vote that had historically been pro forma the ceiling has been raised 78 times since The resulting Budget Control Act of significantly reduced the growth of discretionary spending between and Both in word and deed, Republican lawmakers embraced and enforced fiscal austerity, and the result was the most moribund recovery on record until Of course, spending is just one prong of fiscal policy; taxes constitute the other.
In theory, fiscal policy may not have been as austere as Figure B would indicate if taxes had been cut much more steeply over the recovery from the Great Recession. While tax changes were indeed less contractionary than spending in those years, they were nowhere near expansionary enough to overturn the overall finding that recovery from the Great Recession was severely hampered by overly restrictive fiscal policy.
Figure C compares the business cycles of the s, s, 31 s, early s, and late s. The fiscal impulse stemming from these combined fiscal actions are measured either from peak to peak over the entire business cycle or, more relevantly, from the trough of the recession through the first three years of recovery. The peak-to-peak measure includes the actions undertaken during the actual recession like the Recovery Act , while the measure from the trough plus three years shows the fiscal impulse aiding recovery from the recession.
This fiscal impulse in the first three years of recovery was historically weak following the Great Recession—providing less than a tenth the spur to spending provided after the s and early s recessions, and less than a fifth the fiscal boost provided after the s and s recessions. It is exactly this kind of premature swing into austerity that policymakers must avoid at all costs as the economy enters the next recession. Note: For each fiscal component taxes, transfers, and government consumption and investment , the quarterly growth rate is multiplied by its share relative to overall GDP to get a quarterly contribution to growth.
The figure shows these quarterly contributions expressed as annualized rates. Government consumption and investment spending is adjusted for inflation with the component-specific price deflator available in the NIPA data. For taxes and transfers, the price deflator for personal consumption expenditures PCE is used. A growing conventional wisdom holds that the United States is poorly prepared to face the next recession because it lacks fiscal space to undertake stimulus, and lacks monetary space given short-term interest rates that are not very far above zero the federal funds rate is currently set to a range between 2.
The broader argument—that we have done a terrible job preparing for the next recession—is fair. The given reasons—a lack of fiscal and monetary space—are not. The evidence presented to justify claims of little fiscal space is usually just the federal debt as a proportion of GDP. This ratio in But the measure is an extraordinarily imprecise gauge of fiscal space, and is fundamentally backward-looking, picking up the legacy of past decisions regarding spending and taxes.
More sensible measures of fiscal space would look at future determinants—for example, projected deficits or projected tax burdens relative to other advanced economies. Using these forward-looking measures, by many respects the fiscal space available to the U. This willingness to hold U. Note: Federal debt service refers to interest paid on federal debts. Here it is shown as a percent of GDP. It is clearly true that short-term interest rates will not be able to be cut very far before hitting the zero lower bound in the next recession.
But monetary policy, as noted above, has always been weak tea when it comes to fighting recession and spurring growth. In short, there is little evidence that a lack of monetary space will be particularly constraining for future stimulus efforts either. The United States will head into the next recession with a number of structural drags on growth in aggregate demand. The largest structural drag is continued high levels of income inequality.
Another important obstacle is an inflation target that was set too low and has been insufficiently defended against undershooting for a decade. Besides these mechanical drags stemming from inequality and too-low inflation, the response to the next recovery is likely to be hampered by our failure to properly rein in the power of finance following the Great Recession. Finally, and most importantly, the overwhelming empirical and intellectual case for aggressively using fiscal policy to end the next recession quickly and restore full employment has not filtered through sufficiently to policymakers.
Instead, ingrained habits of thinking have led far too many policymakers to see budget deficits as nearly always and everywhere bad. The rise in American inequality in recent decades is now well-recognized. It is also well-documented that, all else being equal, a redistribution of income from low- and middle-income households toward rich households is likely to sap aggregate demand growth. Bivens a finds that the rise in inequality since reduced aggregate demand by as much as 4 percent in , holding other influences constant.
For much of the period from to , other influences helped counteract this inequality-induced drag on demand. Key influences included a secular decline in interest rates as excess savings from rich households put downward pressure on rates and a number of asset market bubbles that sustained consumption growth for a time.
But the underlying level of aggregate demand today is far lower than it would be had the post rise in inequality never happened, and this makes the job of avoiding and exiting recessions harder. While the causes of this rise in inequality are beyond the scope of this paper, the roots are clearly political: Far too often in recent decades policies were enacted that explicitly redistributed bargaining power and leverage in the labor market away from low- and middle-wage workers and toward corporate managers and capital owners.
When nominal interest rates hit zero, real inflation-adjusted rates will equal zero minus the expected rate of inflation. In recent years, as the zero lower bound ZLB on nominal interest rates was reached, higher inflation that drove real interest rates significantly lower than zero would have been most welcome. But instead the Fed in made official what had long been suspected: Their preferred inflation target was just 2 percent. This 2 percent expected inflation made the ZLB bind tightly in the recession, as it meant real rates could only be pushed to negative 2 percent, when even lower real rates were needed.
A higher inflation target would provide more room for nominal interest rate cuts to boost the economy in the next recession. Given the growing frequency of advanced economies around the world hitting the ZLB in recent decades, and given that the influences leading to this are generally well-known and unlikely to be reversed soon, the case for the Fed adopting a higher inflation target is strong. The case for this is summarized in Bivens b. Even worse than having an inflation target that is too low is consistently undershooting this too-low target.
Yet this is precisely what the Fed did, with the cumulative annualized gap between the target and actual inflation reaching 5 percentage points between and the end of Falling inflation expectations could in turn promote higher real interest rates. Because real interest rates are nominal rates minus the rate of expected inflation, these rates rise as inflation falls.
Going into the next recession, it seems our target inflation rate is not only too low, but it has also been poorly defended against undershooting. This could certainly hurt the next recovery. Federal Reserve aid explicitly tied to providing support for the financial sector began in August and continued for years; it included the creation of historically unprecedented programs to provide liquidity to financial institutions.
This finance-directed aid certainly worked to relieve the fallout of the crisis on these institutions and stem financial market stress. It further expanded during and after the recession into new segments kitchens, travel, and apparel and markets Canada. Companies with high levels of debt are especially vulnerable during a recession, studies show. Overall, the more housing prices declined, the more consumer demand fell, driving increased business closures and higher unemployment. But the researchers found that this effect was most pronounced among companies with the highest levels of debt.
They divided up companies on the basis of whether they became more or less leveraged in the run-up to the recession, as measured by the change in their debt-to-assets ratio. The vast majority of businesses that shuttered because of falling demand were highly leveraged. These deep cuts can impair their productivity and ability to fund new investments. The extent to which high levels of debt pose a risk during a recession depends on various factors.
Companies with lots of debt struggle in part because access to capital slows to a trickle during a downturn. PE-backed firms emerged in better shape, the study suggests, because their owners were able to help them raise capital when they needed it. Issuing equity is another way companies can avoid the burden of debt obligations.
The reality, of course, is that many companies have some level of debt going into a recession. Among the group that had deleveraged, it was Nonetheless, Mueller suggests that if a company thinks a recession is coming, it should consider deleveraging.
Brace up! Next global recession may come in 12222
The researchers relied on data from the World Management Survey of manufacturers, which includes questions on how much autonomy a plant manager has to make investments, introduce new products, make sales and marketing decisions, and hire employees. Companies in which plant managers had little discretion were considered highly centralized; those in which they had a lot of discretion were scored as less so.
The researchers also examined results from a similar survey run by the U. Census and matched them with company reports of sales, employment levels, profits, and other performance measures. And they gathered data on which industries were hardest hit by the Great Recession. They also found that the benefits of decentralization faded as economic conditions improved—a sign that delegation has particular value during uncertain times.
Why did decentralization help? Because decentralized firms delegated decision making further down the hierarchy, they were better able to adapt to changing conditions. For example, they were more aggressive in adjusting their product offerings in response to changes in demand. But the uncertainty of a recession necessitates experimentation, which requires that decisions be made throughout the organization. Even if companies decide not to decentralize, they can try to do a better job of gathering input from employees at all levels when making key decisions.
Some layoffs are inevitable in a downturn; during the Great Recession, 2. However, the companies that emerged from the crisis in the strongest shape relied less on layoffs to cut costs and leaned more on operational improvements, Ranjay Gulati and his colleagues found in their study of public companies.
Hiring and training are expensive, so companies prefer not to have to rehire when the economy picks back up, particularly if they think the downturn will be brief. Layoffs can also hurt morale, dampening productivity at a time when companies can ill afford it. Companies should consider hour reductions, furloughs, and performance pay. So when the Great Recession hit, in , the company took a different approach, as Sandra J.
That saved an estimated 20, jobs. Honeywell emerged from the Great Recession in better shape than it did the recession in terms of sales, net income, and cash flow, despite the fact that the downturn was much more severe. Firms invest in IT during recessions because their opportunity cost is lower. In some parts of the world, policy makers encourage shorter hours as an alternative to layoffs.
Many countries and more than half the states in the U.
Recession 12222 -- or whenever
In a discussion paper for the European think tank Centre for Economic Policy Research, Pierre Cahuc, Francis Kramarz, and Sandra Nevoux found that companies that took advantage of the short-time work program laid off fewer workers and were more likely to survive during the Great Recession. The effect was most significant among the companies most severely hit by the recession and those with the highest levels of debt. According to the researchers, the short-time work approach allowed vulnerable companies to hold on to more of their workforce.
Absent the subsidies, they most likely would have had to lay off more employees, making it more difficult to recover after the recession or causing them to go out of business altogether. The researchers estimate that for every five workers on short-time work, one job was saved. And they estimate that the cost per job saved was less than that of comparable programs; since the alternative was paying unemployment, the program actually saved the French government money. One appealing thing about both furloughs and short-time work is that, as with layoffs, companies have discretion over which workers are affected.
By contrast, across-the-board pay cuts or hiring freezes that fail to consider employee productivity can backfire, damaging morale and driving away the most productive employees.