The dreaded “r” word — “recession” to economists — is being uttered more frequently today in the media. Some think we’re already in a recession, some think we’re about to go into a recession, while others think a recession is still unlikely. For the average non-economist, this is all a bit confusing and concerning. While most people might not know what the technical definition of a recession is, they do know one thing: It’s probably not good.
So let me try to accomplish two goals in this article. First, allow me to bring you up to speed on what a recession is and why recessions happen. Second, I will assess today’s chances for a recession.
Recessions are now new; they are part of the on-going business cycle. Business cycles are the irregular ups and downs in the economy that have been with us as long as we have had the tools to measure commercial activity. There are two main parts to each business cycle. Expansions occur when economic activity, particularly the production of goods and services, is increasing. Recessions occur when the production of goods and services is decreasing. Expansions are steps forward in the economy, while recessions are steps backward.
We’ve had 10 combinations of expansions and recessions since World War II, and fortunately the “steps forward” during expansions have greatly exceeded the “steps backward” of recessions. One of the great achievements of the past 20 years has been that expansions have become longer and recessions have gotten milder. Of course, let me hasten to add, I’m talking about expansions and recessions for the entire economy. Certainly, there have been many industries, regions, and individual households that have seen more economic bad times than good times in recent years.
Why do recessions occur? That’s one of the biggest questions of all time in the economics profession. Economists agree there are at least two factors that can ignite a recession. One is a large increase in the price of some key input in the economy. Oil would be the best example, and big jumps in oil prices certainly contributed to several recessions, particularly those in the 1970s.
A second, more subtle, way that recessions can begin is as a reaction to some excess built up in the economy. The excess manifests itself as a significant price increase in some market. Ultimately, the price increase can’t be sustained, and when investors realize this, the price falls, wealth evaporates, and the declines can push the overall economy into a downturn. The excesses developed in the technology sector in the late 1990s led to the recession of the early 2000s.
Now back to today. Numerous economists have upped their odds of a recession happening because they see not one, but both, of the recession-causing factors present. Oil prices have risen to an all-time high of near $80 a barrel. And the apparent past excesses developed in one market, residential housing, are having adverse effects through lower house prices (in some markets), more foreclosures, cutbacks in the construction industry, tighter credit standards, and an uncertain stock market.
So certainly a reader of the economic tea leaves could come to the conclusion that a recession is here, or near. The timing would also be right. It’s been almost six years since the end of the last recession, and this is longer than the average post-World War II expansion.
But there’s another possibility. This is that the economy avoids a recession but slips into a period of slow growth, of less than 1 percent, during the upcoming months. Then, when much of the housing market excesses have been eliminated and we’ve adapted to today’s oil prices, more normal growth, 3 percent to 4 percent annually returns.
This less-drastic scenario is actually the one favored by the majority of economists. But here’s a sobering fact about economic forecasts: They’re very difficult to make because the most recent aggregate business statistics are usually several months old. Thus, projections for future months have to largely be made in the dark about current conditions. This casts a shadow over any fearless forecast!
Michael L. Walden is a William Neal Reynolds distinguished professor at North Carolina State University and an adjunct scholar of the John Locke Foundation.