Debate on recession prospects has three sides. One side points to still strong jobs growth and contends that the economy will avoid recession altogether. A second side contends that the jobs numbers are misleading and that a recession is imminent. Yet a third side splits the difference, arguing that a recession will wait until 2024.
Forecasting is always a dubious business, especially timing a cyclical turn, but circumstances yield at least two strong probabilities. First, recession, whatever its exact timing, is likely. Already, the effects of high-interest rates and the ill effects of inflation are evident. Second, the recession, when it arrives, should be mild, certainly nothing like the disaster of 2008–09, which still looms large in the collective memory.
Much in today’s circumstances points to the near inevitability of a cyclical downturn. The Federal Reserve has raised interest rates aggressively over the past 15 months. Even with the recent pause in this pattern, it'll still likely administer more hikes in the coming months and, in any case, has made clear that it has no intention of pushing rates down again any time soon. At the same time, inflation has eroded the real buying power of incomes at all levels of society. Already, ample evidence has emerged of the retarding effects of this reality.
Homebuilding may have picked up slightly in April, but more significant is how it has fallen by more than 20 percent over the prior year. Consumer spending has also lagged. Retail sales, although up marginally in April and May, have risen by only 1.6 percent over the prior 12 months. After inflation averaging about 4 percent, that amounts to a significant real decline, which should be no surprise since average weekly earnings have risen by only 3.4 percent over the past year, also failing to keep up with inflation. Orders for capital equipment have fallen by about 1 percent over the past 12 months, and that’s without accounting for the effects of inflation.
Even if the Fed were suddenly to reverse its interest rate policy—not likely until inflation drops to near 2 percent or so—this slowdown would build on itself for a considerable time.
If all this makes recession a compelling prospect, the relative strength of household finances suggests strongly that such a recession will be well contained, certainly not at all like the horrors of 2008–09. Back then, the recession emerged in the face of an enormous debt overhang—much of this debt had burdened vulnerable lower-income people. Because the layoffs and income shortfalls of the initial downturn caused these people to default, the recessionary effects cascaded through the financial system, spreading the economy’s troubles more widely than would otherwise be the case. But now, such a debt overhang doesn’t exist. On the contrary, the household sector has shown remarkable financial prudence.
Even as mortgage rates have risen, Fed data show that households have held down the portion of income absorbed by mortgage payments. At 3.97 percent of income, recent readings are up from lows of 3.48 percent early in 2021, before the Fed began raising interest rates, but the burden has increased only marginally. Most importantly, today’s figure remains well below the 7.2 percent mortgage payment burden on income averaged in 2007, just as the most recent economic correction was underway. Nor has what the Fed calls “revolving credit”—mostly credit card debt—risen much. It absorbs some 5.7 percent of household incomes, up from lows of 4.9 percent in early 2021 but still below the 6 percent that prevailed as the most recent downturn was getting started.
It might also be comforting to realize that despite the spendthrift reputation of Americans, debt use in this country isn’t especially high by the standards of most developed economies. According to the International Monetary Fund, American household debt of all kinds totals about 78 percent of the country’s gross domestic product (GDP). That’s unsurprisingly high compared with poorer countries, where home ownership is uncommon, such as Russia, where household debt amounts to only 22 percent of GDP, or India, where it comes to 35 percent of GDP.
But the American figure isn’t much higher than China’s at 62 percent, France’s at 67 percent, Japan’s at 69 percent, or even Germany’s at 57 percent. The United States looks prudent next to the UK, where household debt amounts to 86 percent of GDP; Canada, where it amounts to some 107 percent; and Australia, where it amounts to 119 percent.
Whether the recession will arrive tomorrow or wait until next year remains an open question. What’s more important is that it’s likely and that it should be mild by historic standards, especially compared with the most recent episode in 2008–09.
