July 27, 2022
Everyone is a pessimist these days. Barely a day goes by without an economist downgrading their forecasts. On July 14th Steven Blitz of TS Lombard, an investment-research firm, said that he was now expecting a recession this year in the world’s largest economy, a day after Bank of America made the same call. Goldman Sachs, another bank, reckons Germany’s GDP shrank in the second quarter of the year and will also do so in the third. Americans’ Google searches for “recession” have never been so high, and by some distance. TikTok, a short-video platform, is full of clips telling Generation z how to budget as the downturn unfolds. Traders are selling copper (a proxy for industrial health), buying the dollar (a sign that they are nervous) and pricing in interest-rate cuts for next year.
Over the past 18 months a number of factors have combined to create a toxic mixture for the world economy. In response to the covid-19 pandemic America overstimulated its economy, provoking inflation not just within its borders but beyond them, as consumers’ voracious demand for goods bunged up the world’s supply chains. China’s attempts to stamp out covid compounded these problems. Then Russia’s invasion of Ukraine caused commodity prices to soar. In response to the ensuing inflation, roughly four-fifths of central banks worldwide have raised interest rates, by an average of 1.5 percentage points so far this year, causing stockmarkets to slump. The Federal Reserve is expected to raise rates for the fourth time in this cycle, and by three-quarters of a percentage point, after a meeting that ends on July 27th.
Fear of the eventual consequences of monetary tightening is at the root of recession worries. It is clear that central banks have to take the proverbial punchbowl away from the party. Wage growth in the rich world is far too strong given weak productivity growth. Inflation is too high. But the risk is that higher rates will end the party altogether, rather than making it less raucous. History is not encouraging in this regard. Since 1955 there have been three periods when rates in America rose as much as they are expected to this year: in 1973, 1979 and 1981. In each case a recession followed within six months.
Has recession struck again? Rich-world economies, which account for 60% of global GDP, have without question slowed since the heady days of mid-2021, when covid restrictions were being rapidly lifted and optimism about the future was growing. Goldman Sachs produces a “current activity indicator”, a high-frequency measure of economic health based on a range of surveys and data. The gauge has in recent weeks clearly slowed (see chart 1). Nicolas Woloszko of the OECD, a club of rich and middle-income countries, has derived a measure of weekly GDP from Google-search data. In the past few weeks, he finds, GDP in the rich world has started to look a lot weaker. Surveys of businesses in the euro zone and America released on July 22nd by s&p Global, a data provider, made for grim reading, with manufacturers gloomier than at any time since the early days of the pandemic.
It looks too soon, though, to declare a recession—even if, as some expect, America’s statisticians reveal on July 28th that between April and June the world’s largest economy contracted for the second quarter running. This would count as a recession by one rule of thumb, but it does not pass the smell test. A series of one-off oddities led American GDP to shrink in the first quarter, even though the underlying performance of the economy was strong. It would also be too soon for Fed tightening to have had an effect.
Most economists look to America’s National Bureau of Economic Research (NBER) to find out if the economy is truly in recession. Its business-cycle-dating committee considers indicators beyond GDP in making that judgment, including jobs numbers and industrial production. The committee is thought to weigh some factors more heavily than others. The Economist has used a similar approach, with a little guesswork, to judge the health of the rich world as a whole (see chart 2). The exercise suggests that it is hard to argue that a recession has arrived.
Yet with growth clearly slowing, the big question is how bad things will get. The few remaining optimists point to the strength of households and firms. The public is even gloomier about the economy than it was during the depths of both the global financial crisis and the pandemic (see chart 3). But households across the rich world probably still have some $3trn or so in “excess” savings accumulated during the pandemic, according to our estimates. In America in March 2022, the latest available data, the cash balances of the lowest-income households remained 70% higher than they were in 2019, according to the JPMorgan Chase Institute, a bank-affiliated think-tank.
Moreover, surveys suggest that people seem more confident about their personal finances than about the state of the economy. Across the eu as a whole, households are about one-third more likely to be positive about their own finances than they have been, on average, since the data began in the mid-1980s. In America the share of people who reckon they will be unable to meet debt commitments over the next three months remains below its long-run average, according to a survey by the New York Fed. Various consumer-spending trackers, including from the Bank of England (for Britain) and JPMorgan Chase (for America), still look fairly strong.
Governments across the rich world are also handing out money to help poorer people cope with roaring energy prices. In the euro zone, governments are stimulating the economy by the equivalent of about 1% of GDP. Britain is unwinding the fiscal support put in place during the pandemic, which is dragging on growth, but has nonetheless offered handouts to poor households. In May the Institute for Fiscal Studies, a think-tank, reckoned that such spending would largely compensate the poorest households for the rising cost of living (though retail energy prices are now likely to rise further still).
The behaviour of businesses is also reasonably reassuring. The rate at which companies post new vacancies has slowed somewhat. Apple and TikTok are the latest firms to reportedly pare their recruitment plans. But across rich economies the number of existing open positions is still near a record high. In Australia, for instance, they are more than twice their pre-pandemic level, according to real-time data from Indeed, a job-hiring website. In America there are more than two open positions for every unemployed person.
As a result, labour markets remain tight. You can find some evidence of rising joblessness in the Czech Republic if you squint. Overall, though, the oecd’s unemployment rate is lower now than it was just before the pandemic. In half of OECD countries the share of working-age people who are in a job—a broader measure of labour-market health—is at an all-time high. If history is any guide, these figures are inconsistent with a looming recession.
Declines in investment have in the past played a big role in downturns: in recessionary periods for the g7 group of large economies since the 1980s, around half the fall in combined GDP in negative quarters has come from shrinking capital spending. This time investment data have weakened, but not catastrophically so, according to data for America, the eurozone and Japan, compiled by JPMorgan.
In late 2021 and early 2022 capital spending boomed, as companies spent big on remote-working technology and reinforced supply chains. Now some firms believe they have overinvested in extra supply capacity. Others want to conserve cash. An analysis of survey evidence, financial markets, credit conditions and corporate liquidity by Oxford Economics, a consultancy, suggests that investment in the g7 could decline at an annualised pace of around 0.5% in the second half of this year. That is not good, but it is not enough to create a recession by itself. The investment declines in past recessionary episodes, for instance, were steeper.
Unfortunately there is a limit to the confidence that can be taken from good economic data when the fundamental fear of investors is monetary tightening. Today, news of any kind, it seems, can convey bad news about a recession. Weak data confirm that a downturn is approaching. Strong data, including wage rises, suggest central banks are not succeeding in slowing things down, requiring further tightening, which in turn stands to provoke a recession. However strong consumers and firms look, only signs that inflation is falling will truly dispel fears of a downturn.
True, there is some relief on the horizon. An index of supply-chain problems compiled by the New York Fed, comprising global transport costs and the opinions of purchasing managers, among other things, has clearly eased, though it remains well above the pre-pandemic norm (see chart 4). Commodity prices have come down since June. American petrol prices at the pump are currently falling by about 3% a week. Alternative Macro Signals, a consultancy, runs millions of news articles through a model to construct a “news inflation pressure index”, which indicates whether the news flow suggests price pressures are building up. The indices for America and Britain have fallen in recent days.
But hopes for a rapid fall in inflation are almost certain to be dashed. Past increases in the price of food and energy have not yet fully filtered into headline inflation rates: Morgan Stanley reckons that rich-world inflation will peak at 8% in the third quarter of 2022. Other than in America’s volatile monthly data, growth in wages shows little sign of easing. In earnings calls companies still talk about how best to pass on higher costs to their customers. On July 21st Russia seemed to indicate that it would not turn off the gas taps to Europe, which if it did would doubtless provoke a recession on the continent. But its promises are not worth much.
The mass of data confronting economists is useful, but an old lesson may still hold: that recessions are hard to spot in real time. The NBER dates the start of America’s downturn associated with the global financial crisis to December 2007. But in August 2008 the Fed’s staff thought the economy was still growing at an annual pace of about 2%. Even after Lehman Brothers collapsed later in the year, the IMF said that America was “not necessarily” heading for a deep recession. Understanding the economy at the best of times is hard enough; this time it does not help that the post-lockdown economy has been full of surprises. Practically no one predicted that labour shortages would emerge last year, or that inflation would go from bad to worse in 2022.
That is the case for pessimism. The case for optimism is that the present episode of monetary tightening has only just begun. Before it bites there is time for an unusually volatile world economy to deliver more surprises—perhaps even positive ones. ■