Local evidence and discussion of the recession question
Update since Tuesday: inflation statistics for the region came out on Wednesday; the headline number is a 9.2% year-over rate which is still higher than the national average and below even Los Angeles’ 7.7% rate. In short, this was not a good report for the Inland Empire; my colleague Nate Cline has a more nuanced breakdown in the Redlands Community News (highly recommended). I’ll have more to say about it in next Tuesday’s regular economic update.
The big question on people’s minds these days is whether we are in a recession. Many analysts have weighed in on this, and instead of trying to add another take (although my recent writings do reflect my views; I’ll link them below where appropriate), I am going to attempt to link these recession concerns to the local economy while synthesizing what has been written locally. The consensus appears to be “no, we are not currently in a recession”, but there are some early signs that we are about to dive into one.
To start, there are two main reasons why people think we’re in a recession:
· Two consecutive quarters (Q1 and Q2 of 2022) of declining real GDP, documented by the Bureau of Economic Analysis
· Many stories of weakening labor and real estate markets, caused by higher interest rates initiated by the Federal Reserve in March 2022
The regional data simply cannot address these (admittedly incomplete) views. Even if GDP were also declining out here, which Keil, Kleinhenz, and Li think it is not, two quarters of declining real GDP is not enough to call a recession. An economy also needs to experience a general decline in activity, especially in investment and (secondarily) consumption; this is Thornberg’s major argument, which notes that industrial production, import, and job growth remains high and inventories remain low.
Concerning interest rates, monetary policy comes with a lag of at least 6-9 months, so even if higher interest rates will weaken the economy, we will not see that effect until Q3 or Q4 of 2022.
On the other hand, there are many reasons why people think we’re not in a recession:
· High job growth (nationally but also in the IE)
· New claims for unemployment insurance, while rising nationally, are not rising as fast as we thought; and regionally they remain low
· Business inventories are low and import growth (after correcting for inflation) remains strong
So the question is, what happened to cause people to think we are in a downturn? The main argument here is from Dr. Christopher Thornberg, who ultimately argues that the supply side of the economy essentially became “confused” during the pandemic. Social restrictions shut down many services, but with relatively strong incomes and fiscal stimulus during this time, spending didn’t decline as much as it usually does in recessions; instead it simply shifted away from services and towards goods, as well as to assets like housing.
When social restrictions ended, consumption shifted back to services, causing inflation in that sector to kick in last year (which also drove gas prices up), but consumption of goods remained at a somewhat higher level. Suppliers have yet to adjust to whatever the new normal is (arguably, it still doesn’t exist), and this has caused a lot of confusion and mislaid plans.
Add to this the very real demographic implications of the pandemic – the wave of early retirements, exits from the labor force from older and some younger workers – and the story appears more and more about “supply”.
Even with these arguments however, Michael Roberts does note declining profit rates and investment, which are both early signs of a slowdown. When economists refer to “investment” they mean purchases of capital equipment, machinery, and other tools to produce goods and services, and the latest data do show a decline in investment; see here. Investment is crucial, because if businesses are not expanding their capacity to produce with new capital, then they will eventually start laying off workers as well. I would argue that this is the one piece of data that even Thornberg might have overlooked in his analysis.
While it would be great to have more evidence of precisely what’s happening locally, the national outlook does suggest a looming downturn; it’s simply too early to call it an official recession yet.