Economist Writing Every Day

Will a recession happen? It’s famously hard/impossible to predict. Personally, I have a relatively monetarist take. I consider the goals of the Federal reserve, what tools they have, and how they make their decisions. I also think about the very recent trend in the macroeconomy and how it’s situated relative to history. Right now, the yield curve has been inverted for quite some time and the Sahm rule has been satisfied, both are historical indicators of recession.

Recessions are determined by the NBER’s Business Cycle Dating Committee. They always make their determination in hindsight and almost never in real time. They look at a variety of indicators and judge whether each declines, for how long, how deeply, and the breadth of decline across the economy. So plenty of ‘bad’ things can happen without triggering a recession designation.

In my expert opinion, recessions can largely be prevented by maintaining expected and steady growth in NGDP. This won’t solve real sectoral problems, but it will help to prevent contagion and spirals.  The Fed can control NGDP to a great degree. In doing so, they can affect unemployment and growth in the short run, and inflation in the medium to long run.

One drawback of the NGDP series is that it’s infrequent, published only quarterly. It’s hard to know whether a dip is momentary, a false signal that will later be updated, or whether there is a recession coming. So, what should one examine? One could examine leading indicators or the various high-frequency indicators of economic activity. But those are a little too much like tarot cards and fortune telling for my taste.

The analysis isn’t whether we’re headed for recession. It’s whether the Fed will increase total spending. That may seem like a slightly different question, but it requires a very different type of analysis. Think something closer to industrial organization rather than macroeconomics. They care about highly dependable indicators. The daily stuff is too noisy, the weekly stuff may not be broadly representative, but quarterly is too slow. So, they put a lot of stock in the monthly indicators. What do those say?

Inflation: We’ve had two months of below target inflation. That’s not outrageous and it doesn’t mean that inflation has been beaten. A 3^rd month below 2% would be a bit more exceptional. I prefer to use the standard PCE price index *including* energy and food. Why? Because those prices are also indicators of demand and we are concerned with the short run.

Spending: The largest component of NGDP  is consumption, at about 70%. The largest component of Consumption is spending on services at about 65% and we have data through June 2024. The May and June consumption spending is grew at 5.3% &  3.6%, which is perfectly fine. Consumption spending on services has been steady at just under 5% for 3 months in a row. Peachy keen.

Unemployment: Unemployment recently came in at 4.3%. That’s ‘fine’. It’s not high by historical standards, but it is higher than it’s been recently. Rather, I prefer to look at the growth rate of employment. Employment growth has been slowing and total employment has had some negative blips. That could mean a coming recession, but there are just as many such cases in history that didn’t result in recession. So I’m not too worried at this time.

Money: Velocity as been falling for twenty-five years. Right now, we’re on trend and maybe a little high, which could place downward pressure on GDP if it the trend continues. But velocity is a quarterly indicator. Remember when I said that the Fed has a variety of tools? Well, if velocity might be falling, then what’s been happening to the money supply? It’s mostly flat. If you squint a little, you can say that M2 has been slowing rising since October 2023, but it’s been SLOW. In other words, the Fed knows the multi-decade trend in velocity and has recently eased some. In other words the Fed is paying attention (interest rates are not a dependable sign of monetary policy).

What do I think? I think that the Fed looks at the data. Their next meeting is September 17-18^th . What data will they have? By the end of August, they’ll have the July PCE data, but not the August data. They will have the less dependable and more volatile CPI data for August. By the time of their meeting, they’ll have more data for all of the above than we have now.

The Fed has a perpetual credibility challenge. If the Fed is seen as being twitchy, then people won’t anchor their inflation expectations because they’ll perceive the Fed as more worried about recessions than inflation. If the Fed is too slow to act, then it will have helped to push us into recession. Right now, I think inflation expectations are not yet adequately anchored. The Fed still has something to prove. Despite any TIPS rates or expert forecasts, the proof is in the pudding. The best way for the Fed to credibly commit to low inflation is for them to achieve it. And, they haven’t quite done it for more than a couple of months at a time yet.  

Therefore, barring absolutely dismal new numbers, I think that the chance of a September rate cut is slim. Earlier this year, I told my classes and others that I personally did not expect any rate cuts in 2024 – contrary to market and expert expectations (they were forecasting multiple cuts). So far, I’ve been right. I stand by my forecast. But a December rate cut is closer to a toss-up right now (I say it happens with a 45% chance).  

Should you trust me? I don’t know. I know that people over-forecast action. I know that I tend to be temperamentally sanguine when it comes to the macroeconomy. I was right about the peak of the post-Covid inflation, the big rate increases happening in 2022 and their continuing rise in 2023 (I bought my house with my profits). Ultimately, it comes down to the data. At the one-month horizon, I consider it a random walk.