Has The Recession Started?

Context

• According to one widely accepted definition, the US economy is on the verge of a recession. However, that is not the definition that is important.
• The government estimates the gross domestic product for the April-June period on Thursday, and some economists believe it will show that the economy shrank for the second consecutive quarter. That would confirm a long-held assumption about when a recession begins.

Relevance

GS Paper 3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Mains Question

Discuss past recession trends in India and explain how the upcoming downturn of USA differs from previous downturns. (250 Words)

What is Recession?

• The term “recession” refers to a period of economic decline in a country.
• It is a transitory period in which we will see a decline in trade, industrial activity, employment, and so on. In general, when a country’s GDP (gross domestic product) falls for at least two consecutive financial quarters, we can call this a recession in the economy.
• As a result, during a recession, the entire country’s economic performance stagnates.
• Businesses across the country will suffer the effects of the recession. To some extent, the government will be helpless as well.
• Consider the global recession of 2007-2008. It began with the housing market collapse in the United States, but the global economy suffered as well, with negative consequences seen in India.

Causes of a Recession

1. High Bank Rates: When interest rates are extremely high, there is little liquidity in the market. As a result, investment will fall, resulting in an economic slowdown. We saw this in the United States in 1980, when interest rates were raised to combat stagflation. However, this resulted in a recession.
2. Stock Market: During a bear market, investors will withdraw funds from the stock market. This will drain capital from businesses, causing an economic slowdown. Stock market crashes are extremely damaging to the economy.
3. Housing Crisis: When house prices fall, owners begin to lose equity. They are unable to pay their mortgages or obtain second mortgages on their properties. This could result in a foreclosure. This was the root cause of the 2007 Great Recession.
4. Economic Scandals and Frauds: In order to increase profits, banks, large corporations, and even government institutions may engage in questionable practises and illegal activities. The entire economy suffers when such schemes and scandals are exposed. Consider the current Sahara financial scandal.
5. War Effects: Following a war, there is usually an economic slowdown. It is the general aftereffect of the economic stress caused by war.
6. Deflation: The inverse of inflation is deflation. In this case, we will see a general decrease in commodity and service prices. This encourages consumers to wait for further price reductions. This has the potential to cause an economic downturn.
7. Falling Wages: When workers’ wages and salaries do not rise at the same rate as the economy’s inflation, the public’s purchasing power falls. He will be unable to afford the same goods and services that he previously could. This has the potential to cause an economic slowdown.

What Economists Say

• According to economists, this would not indicate the start of a recession.
• During the six months when the economy could have contracted, businesses and other employers added 2.7 million jobs — more than most entire years prior to the pandemic.
• Wages are also rising at a healthy rate, despite the fact that many employers continue to struggle to attract and retain enough workers.

The Fed Reserve’s Action

• The strength of the labour market is a major reason why the Federal Reserve is expected to announce another significant increase in short-term interest rates.
• Several Fed officials have cited the economy’s healthy job growth as evidence that it should be able to withstand higher interest rates and avoid a downturn. Many economists, however, are sceptical of that claim.
• The Fed is also attempting to combat raging inflation, which hit 9.1 percent annualised in June, the highest level in nearly 41 years.
• Rapid price increases, particularly for necessities such as food, gas, and rent, have eroded Americans’ incomes and led to significantly more pessimistic views of the economy among consumers.

The Recession and the Factors

• The most widely accepted definition of a recession is that established by the National Bureau of Economic Research, a nonprofit group of economists whose Business Cycle Dating Committee defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
• Before publicly declaring the end of an economic expansion and the birth of a recession, the committee considers a wide range of factors — and it frequently does so well after the fact.

Is the economy shrinking — or not?

• It did so in the first three months of the year, when GDP contracted at an annual rate of 1.6 percent. According to data provider FactSet, economists predict that the government will estimate the economy grew at an annual rate of just under 1% in the April-June quarter on Thursday. That forecast, if correct, would indicate that the economy is not technically in recession by any definition.
• Even if growth falls for the second quarter in a row, Fed officials and Biden administration economists point to a lesser-known metric known as “gross domestic income.”
• GDP calculates the value of a country’s output of goods and services by adding up consumer, business, and government spending. GDI, on the other hand, attempts to measure the same thing by assessing income
• The two measures should track each other over time. However, they frequently diverge in the short run. GDI increased by 1.8 percent in the first quarter, outpacing GDP’s 1.6 percent decline.
• The NBER uses an average of the two measures to determine whether an economy is in recession. The average in the first quarter was 0.2 percent, indicating that the economy was performing well.

What else does the NBER monitor?

• In determining recessions, the NBER examines a wide range of data points, including income, employment, inflation-adjusted spending, retail sales, and factory output.
• It emphasises employment and a measure of inflation-adjusted income that excludes government support payments such as Social Security.
• That metric takes into account the total income of all workers, so it rises when the unemployed find work or existing workers get a raise.
• Following a flat reading in the first quarter of this year, the measure increased slightly in April and May.

Why people think a recession is coming?

• Because many people are feeling more financially burdened these days.
• With most people’s wage gains trailing inflation, higher prices for necessities like gas, food, and rent have eroded Americans’ purchasing power.
• Higher gas and food prices have forced shoppers to cut back on discretionary purchases such as new clothing, indicating that consumer spending, a key driver of the economy, is weakening.
• Walmart, the country’s largest retailer, has reduced its profit forecast and stated that it will have to discount more items such as furniture and electronics.
• The Fed’s rate hikes have caused average mortgage rates to more than double from a year ago, to 5.5 percent, resulting in a sharp drop in home sales and construction.
• Higher interest rates will almost certainly reduce businesses’ willingness to invest in new buildings, machinery, and other equipment. Companies will begin to slow hiring if they reduce their spending and investment. Companies’ growing reluctance to spend freely may eventually result in layoffs.
• Consumers would cut back on spending if the economy lost jobs and the public became more fearful.
• According to Goldman Sachs economists, the Fed’s rapid rate hikes have increased the likelihood of a recession in the next two years to nearly 50%. And economists at Bank of America now predict a “mild” recession later this year.

Signs of an impending recession:

• A steady increase in job losses and a surge in unemployment, economists say, would be the clearest indication that a recession is underway. In the past, an increase in the unemployment rate of three-tenths of a percentage point over the previous three months has signalled the start of a recession.
• Many economists track the number of people who apply for unemployment benefits each week to see if layoffs are getting worse.
• Last week, the number of applications for unemployment benefits reached 251,000, the highest level in eight months. While this is a potentially concerning sign, it is still a historically low level.

Signals to watch for:

• Many economists also watch changes in interest payments, or yields, on various bonds for signs of a recession, known as a “inverted yield curve.”
• This happens when the 10-year Treasury yield falls below the yield on a short-term Treasury, such as the 3-month T-bill.
• That’s unusual. Longer-term bonds typically pay investors a higher yield in exchange for locking up their money for a longer period of time.
• In general, inverted yield curves indicate that investors anticipate a recession that will force the Fed to cut interest rates. Inverted curves frequently precede recessions. Still, after the yield curve inverts, it can take 18 to 24 months for a downturn to occur.
• For the past two weeks, the two-year Treasury yield has surpassed the 10-year yield, indicating that markets anticipate a recession soon.
• However, many analysts believe that comparing the 3-month yield to the 10-year yield has a better track record for forecasting recessions. These rates are not currently inverted.

Will the Fed raise rates despite a slowing economy?

• The economy’s flashing signals — slowing growth combined with strong hiring — have put the Fed in a difficult position.
• It is aiming for a “soft landing,” in which the economy slows hiring and wage growth without causing a recession and inflation returns to the Fed’s target of 2%.
• Russia’s invasion of Ukraine, as well as China’s COVID-19 blockades, have raised prices for energy, food, and many manufactured parts in the United States.
• Powell has also stated that if necessary, the Fed will continue to raise rates even if the economy is weak in order to keep inflation under control.