Not a week goes by or a prominent newspaper warns that a recession is looming. Brexit, trade wars and a loss of consumer confidence would endanger the global economy. After years of high economic growth, the economy would be in for a tough ride. However, this seems to be a premature conclusion. I will argue that there are only moderating effects on economic growth and that a recession will not occur in the United States.
Empirical evidence has it that recessions have never been caused by a loss of consumer confidence alone. Rather, they have always been accompanied by a tightening of financial conditions. Currently, these are not on the horizon as the Federal Reserve is cutting interest rates. If a recession is indeed around the corner, it could come from three sources: tightening financial conditions, macroeconomic imbalances or the occurance of an external shock. Regarding financial conditions, a contraction of either monetary or fiscal policy is highly unlikely. The Federal Reserve is cutting interest rates and President Trump will only spend more, not less, as the 2020 elections are coming up. There seem to be no large, distortionary macroeconomic imbalances either. Finally, external shocks could occur but are of course impossible to accurately foresee. Conclusion: no recession as long as monetary policy remains accommodative.
Econometric studies estimate the loss of economic output to equal approximately 0,8% in the US.
One of the most cited causes of a possible recession is the ongoing trade war between the US and China. At the moment of writing, President Trump has vowed to tax the entire 550 billion in imports from China at various tariff rates. They will all be in effect as of December 15 of this year. Last week we saw some rapprochement as China is about to celebrate the 70th anniversary of the Revolution, but economists are generally worried about the ongoing economic conflict. Nevertheless, the tariffs have so far had only limited impact on economic growth. Also, businesses are not willing to leave China as President Trump would want them to.
No business is going to fire people if the unemployment rate is around 3,5%.
Econometric studies estimate the loss of economic output to equal approximately 0,8% in the US. Furthermore, the economy will continue growing at a yearly rate of 2,5% for the coming 18 months. Why is that? No business is going to fire people if the unemployment rate is around 3,5%. It is difficult to hire good people, so why fire them if the economy is still booming? The labor market remains incredibly strong. Therefore, the trade war is only a headwind but will not be the catalyst of an American recession. The economy will remain on a sustainable growth path.
Another source of worry shared by many economists is the low level of interest rates. Despite the rate hikes experienced over the past years, they remain historically low. This would leave little room for monetary stimulus should a recession arise. Currently, the Federal Funds rate target as set by the Fed is 2 – 2,25%. The Fed is lowering interest rates for three reasons. Firstly, inflation is below target, which justifies lowering interest rates. Secondly, investment remains weak, which must be stimulated to increase economic growth. Thirdly, the Fed is acting preventively to avoid recession. At the current levels, the Fed has ammunition to fight a mild recession. But as a recession is unlikely to occur, the low interest rate environment does not pose much of a problem to the economy, at least not in the US.
The United States economy is overall doing very well, with an exceptionally strong labor market providing sustainable economic growth. The trade war has only moderating effects on GDP growth, while there is some room for monetary stimulus should economic activity slow down significantly. As long as the Fed does not tighten financial conditions, global worries about an upcoming recession will prove unfounded. The only way is up.