Commentary

When the spring quarter’s gross domestic product (GDP) showed a decline, a great media debate ensued about whether the economy is already in recession. Those who say yes point to the commonly held definition that a recession is two consecutive quarters of declining real GDP, and the news seems to fit that criterion.

The White House, understandably, resists this view, and references more subtle definitions. But for those who want to live in the real world, this debate smells of sterile semantics. Reality is clear: the U.S. economy is weak, and if not already in recession is likely to go into one relatively soon. Indeed, the economic harm of inflation and the financial strains of the Federal Reserve’s (Fed) efforts to fight it make recession all but inevitable.

The worst economic news to date came with the GDP report (pdf) from the Bureau of Economic Analysis. Overall, it showed real economic activity declining at a 0.9 percent annual rate. More telling was the widespread nature of the weakness. Real consumer spending showed modest real growth but slowed dramatically from the pace of the year’s first quarter. Residential construction tumbled in real terms at a 14 percent annual rate. Business spending on structures and equipment, including technology, also fell. Even real government spending shrank.    

And that was not the only bad news. The Purchasing Managers’ Index for July came in at a level of 47.5, well below the level of 50 that demarcates the distinction between growth and decline. One part of the Labor Department’s employment report, the part that surveys households, showed an employment decline of 315,000 for the month of June.

Not all figures were downbeat though. The Labor Department’s survey of employers showed a marked contrast from the picture provided by households, indicating a 372,000 jump in June payrolls. Retail sales for June showed a robust rise of better than 12 percent at an annual rate. New orders for capital equipment have risen at an almost 9 percent annual rate over the past couple of months. Though initial claims for unemployment insurance rose in the week of July 16, the figure was still low by broad historical standards.

Whatever the current balance of evidence, the recessionary prospect lies in the likely persistence of inflationary pressures. Of course, ongoing supply chain problems will lift, probably soon, as will the effects of the Ukraine war, even if it drags on.  But inflation will persist nonetheless because it mostly stems from over a decade of extremely easy monetary policies financing Washington’s considerable deficit spending. Consider that in just the past couple of years, the Fed has used new money to buy about $5 trillion in new government debt, the digital equivalent of financing government with the printing press and a classic prescription for inflation.

This kind of well-entrenched inflation could bring on recession all on its own. The longer it lasts, the more its distorting economic incentives will discourage the saving and investment that serve as the ultimate engines of growth. More pointedly, persistent inflation will force the Fed to take more extreme steps than it has to date. As dramatic as the Fed’s actions seem, they have hardly constrained credit or discouraged borrowing and spending. Consider that even after the Fed’s recent, seemingly dramatic moves, the benchmark federal funds rate of 2.25 percent remains well below the rate of inflation. That interest fails to compensate lenders for the lost buying power of the funds when they are repaid. A strong inducement to borrow and spend thus remains. Before the Fed can brake inflation’s momentum, it will have to raise interest rates close to or above the prevailing rate of inflation. That is a long way from where we are now and would certainly precipitate recession.

Fed Chairman Jerome Powell at his last press conference announced that the Fed, as it fights inflation, will strive to achieve what he called a “soft landing,” that is avoid recession. He also told the reporters that soft landings are historically “rare.” In effect, he put forward recession as the likely result of the Fed’s efforts. If the Fed does its job well, the economic decline should not extend too far into 2023. If, however, the Fed fails to act forcefully enough, the full extent of the economic setback may be delayed, but it will go deeper and last longer, for then the economy will have to deal with the distortions of a truly entrenched inflation.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Milton Ezrati

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Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and chief economist for Vested, a New York-based communications firm. Before joining Vested, he served as chief market strategist and economist for Lord, Abbett & Co. He also writes frequently for City Journal and blogs regularly for Forbes. His latest book is “Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live.”