The economist David Rosenberg says it’s not just possible but likely that the U.S. economy will fall into a recession this year, partly because, he says, the Federal Reserve will go too far in raising interest rates to fight inflation, which is at a 40-year high.
Rosenberg, the president, chief economist and strategist of Rosenberg Research in Toronto, admits that he’s in the minority among economy-trackers in foreseeing an imminent recession. But he makes a persuasive case that deserves a fair hearing.
“I have 2,600 clients in 40 countries,” Rosenberg told me on Tuesday. “I never could claim that I get every call right, but I’m notoriously able to forecast when a storm is coming in.” He was early to spot the dot-com bubble that burst in 2000 and the housing bubble that burst in 2008.
The Federal Reserve’s Federal Open Market Committee concluded a two-day meeting on Wednesday at which it raised the target range of the federal funds rate a quarter percentage point to a range of 0.25 percent to 0.5 percent, the first increase since it cut the range to near zero shortly after the pandemic began. Members of the committee predict that the bottom of the range will reach 1.75 percent by the end of 2022 and 2.5 percent or 2.75 percent by the end of 2023, according to the median projections in the “dot plot” released on Wednesday.
That’s a lot of monetary tightening. High interest rates suppress inflation fairly effectively, but they do so by choking off the demand side of the economy, making it more expensive for both consumers and businesses to borrow. So in trying to steer clear of the Scylla of inflation, the Fed could inadvertently plunge the U.S. economy into the Charybdis of recession.
Rosenberg said an alarm went off for him when he watched the Federal Reserve chair, Jerome Powell, praise one of his predecessors, Paul Volcker, who aggressively raised interest rates in the early 1980s to curb inflation. In congressional testimony this month Powell called Volcker “the greatest economic public servant of the era.”
Volcker did stop inflation but at the cost of two recessions. “People tend to forget that in the early 1980s Volcker was reviled,” Rosenberg said. “And no one really knows if inflation was going to fall anyway.”
Higher interest rates hurt the stock and housing markets, which matter to the economy more than ever before. U.S. households and nonprofit organizations had nearly $50 trillion worth of stocks at the end of 2021, up from $14 trillion a decade earlier, according to Federal Reserve data. And housing prices relative to income have reached the highs of the early 2000s housing bubble. If a bear market in stocks, housing or both makes people feel poorer, they will spend less, which means less income for someone else.
High rates aren’t the only threat to the U.S. economy. Inflation itself can be recessionary: High prices of energy and food, exacerbated by the war in Ukraine and sanctions on Russia, restrain growth by leaving consumers with less money to buy other stuff. When food and energy prices have increased this much in the past, recessions have followed 90 percent of the time, Rosenberg calculates. The U.S. economy could also suffer knock-on effects if the war in Ukraine causes a recession in Europe, he said. And China’s efforts to snuff out a Covid-19 outbreak could once again disrupt supply chains.
Making matters worse, the emergency pandemic assistance that contributed to the current bout of inflation by amplifying consumers’ buying power is going away like a receding tide. Rosenberg calculates that fiscal stimulus passed by Congress added five percentage points to the rate of economic growth a year ago, but the subsequent expiration of pandemic aid will reduce the economy’s growth rate by nearly three percentage points by the end of this year.
To be sure, Rosenberg is more bearish than most economists and policymakers. On Wednesday the Fed released a survey of Fed governors and reserve bank presidents showing median projections for economic growth of 2.8 percent this year and 2.2 percent in 2023. “We do feel that the economy is very strong and well positioned to withstand tighter monetary policy,” Powell said at a news conference on Wednesday.
Capital Economics told clients on Wednesday, before the Fed’s announcement, that it puts the risk of a recession in the next 12 months at just 2 percent. I spoke to several other experts before the announcement who were also more optimistic than Rosenberg. Kathy Bostjancic, chief U.S. economist of Oxford Economics, wrote to me in an email that a Fed-induced recession “is a low but rising risk for 2023.” For now, she wrote, “strong momentum, a very healthy labor market and a healthy consumer balance sheet should keep growth humming this year.”
James Hamilton, an economist at the University of California, San Diego, told me the federal funds rate is too low, especially given bottlenecks in the economy that restrain supply, and while higher rates will curb growth, “based on what’s happened so far I don’t think it’s enough to cause a recession.” Guy LeBas, chief fixed-income strategist for Janney Montgomery Scott in Philadelphia, took a similar line, saying that recessionary factors “get weighed out by strong job and wage growth in the short term.”
Barry Ritholtz, an investor and blogger, wrote on Monday that Fed officials understand the danger of raising rates too quickly. “The Fed wants to get off of its emergency footing,” he wrote. “They are jawboning against inflation, but they understand exactly how ineffectual increases are in the current environment.” He said that he would like to see the Federal Open Market Committee “return to a more normal footing — eventually — but those expecting fast, fat and frequent rate hikes might be setting themselves up for disappointment.”
The biggest danger from today’s inflation is that expectations of high inflation become embedded in the markets and the views of consumers and businesses. But there’s not much evidence of that yet. The Federal Reserve Bank of New York surveys consumers about their expectations for inflation three years ahead. The median expectation in February, 3.8 percent, was barely higher than the median expectation of 3.4 percent when the survey began in June 2013 and actual inflation was under 2 percent.
Rosenberg said he’d like to see the Fed stop with the rate hikes after this month’s increase, even though he knows that his negativity is out of favor. “Most economists on Wall Street like to play it safe because that ensures your job longevity,” he said. “That’s why I started my own firm. My goal is not to make my clients happy. If it were I would have started Rosenberg Circus instead of Rosenberg Research.”
Elsewhere
The kids are not all right, judging from a February survey of 2,000 financial-sector workers in France, the United States and Britain on behalf of LHH, a subsidiary of the Zurich-based employment-services company Adecco.
The survey, released on Wednesday, found that 55 percent of the 18- to 24-year-olds surveyed were anxious about change, more than any other age group. Only 67 percent of these young people felt psychologically safe at work, less than any other age group. They were also the least likely to feel included, to believe in themselves, to be optimistic, to get along with colleagues and to feel in control of their next step in life. You might think they would at least feel more comfortable around technology. Nope. Their age group was the most worried about tech and automation.
Quote of the day
“When realism and relevance butt heads with analytical tractability, tractability almost always wins out in economics.”
— David S. Evans and Keith N. Hylton, “The Lawful Acquisition and Exercise of Monopoly Power and Its Implications for the Objectives of Antitrust,” in Competition Policy International, Vol. 4, No. 2, 2008
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