Paul Krugman says today that the economy is looking "pre-recessionary." He blames the Fed:
What’s especially galling about the current situation is that we may be about to snatch defeat from the jaws of victory. As of right now, America has basically achieved what many economists had considered impossible: a soft landing, in which we managed to get inflation way down without high unemployment. But we are increasingly at risk of experiencing a lot of unnecessary pain simply because the pilot waited too long to pull up the plane’s nose.
I've got a couple of things to say about this. The first is that the soft landing talk was always ridiculous. When you're on the way to a hard landing, there's always a point where the landing looks soft if only things just stop right there. But of course there's no way to know. Usually they don't.
The second is that no one should be surprised by what's happening. As you all know, I've been predicting a probable recession for a long time, and you might think I've changed my mind on that since I haven't mentioned it lately. Not at all. It's always been the case that recessions start 1-2 years after the Fed hikes interest rates, and we're admittedly at the far edge of that. But it's hardly a firm rule. Several recessions have started 2½-3 years after the Fed started raising rates.
I haven't mentioned this very much recently because I didn't want to come off as Chicken Little. But nothing has changed. The Fed never needed to raise rates more than modestly since our recent bout of inflation was caused primarily by COVID, not a frothy market. (Surely nobody contests this anymore?) But they did, and the result is that they hit the brakes on an economy that was healthy but not overheated. There's only one way for that to end: in recession.
If we're still not in recession a year from now, I'll concede defeat. Miraculously, the Fed will have raised rates more than 4% and engaged in considerable quantitative tightening—and produced nothing. If that happens, though, a whole bunch of intro macroeconomics textbooks will need an emergency update, because this has literally never happened before. I wouldn't count on it happening this time either.
Yes KD, you have indeed predicted that the Fed tightening would result in an unnecessary contraction. And it is true! The Fed has kept rates to high for way too long impacting the housing market, risk allocation, and all other goodies that benefit the rentier class. However, there is a difference between having the GDP go to negative growth and the economy not realizing it’s full potential. As long as we stay at full employment (“classic model”) I doubt we would have a recession and layoffs have been low because companies did not over hire. So in the grand scheme a quick substantial reduction will get the Fed out of the pickle of their own creation. GDP growth has been steady the last few quarters and apart from lower profit expectations by very large companies, not much has changed fundamentally. The market was due for a correction and now the Fed is due for one too. The Fed was supposed to cut 50 basis point and did not probably due for a combination reasons including being so political averse that they overcompensated (the Comey rule)- not a good look at all. They might as well cut 100 next time precisely to avoid being in the same quandary again.
As always the economic data is a mixed bag. The Household survey indicates that roughly 1.3 million people have entered the labor force over the last 12 months, almost no jobs have been added and the number of unemployed has increased by nearly 1.3 million. Among those with jobs we see a higher amount of people working part time when they would prefer to work full time.
This looks...not great.
But....other data looks less recessionary and the beatings must continue....these are just regular laborers we are talking about
Not that it makes much of a difference in this case, but when Kevin presents charts of CPI et al, he adds a 2nd order polynomial trend line. But for this, it's a 1st order polynomial. I wonder why.
That's not the real problem with this graph. Everyone understands that the job growth in 2021-2 is an anomaly. It's just recovering jobs that were lost during COVID. We crossed the point where those jobs were all made up in late 2022. A reasonable presentation of the data would not include this period. Hold your hand over the 2021-2 period. What do you see? There's still a downward trend, but it's not nearly so steep. Everyone is losing their minds over one month's data, as if no one has ever seen such a thing before. Keep your powder dry. Next month will be better and everyone will have forgotten about it.
We weren't going to avoid a recession indefinitely. We haven't repealed the business cycle. I'm cautiously optimistic this all works out for Harris. My guess is markets stabilize in the coming weeks, and the downturn doesn't begin to bite strongly enough to affect the outcome of the election (my prediction: the recession ends up being timed as October 24-August 25). We'll likely see falling mortgage rates and gas prices this autumn. That's good for the Democratic brand provided the economy hasn't fallen off a cliff. And there seems to be little chance of the latter, given the existence of equities bargain hunters and the high probability of Fed easing.
Post war expansions have lasted an average of about about 5 years, I think, and they've gotten longer the further we've travelled from WW2 (the 2020-2024 expansion will end up being an outlier, obviously). In other words: if I'm right, the economy should be growing nicely again well before the 2026 midterms, and 2028 should see optimal conditions for the incumbency party.
Kamala had better win this thing, because either way, the incoming party is nicely set up for the next two cycles.
Tell me when, during the leadup to the 2008 recession, people thought there was a soft landing. My recollection was, people were hoping that duct-taping the economy would hold it together, but no talk about having reached a soft landing. It was either people like John McCain unaware of the status of the economy and everyone else whose hours were being cut back just so that they could hold onto a job, only to see things worsen.
You know, now might be a good time for you to actually give a damn about the Beveridge Curve / V/U ratios, you know, since you're into historical trends and all.
If memory serves there was a pretty long run of soft landing commentary in the 12-24 months between the housing peak and the recession.
Then the convo changed and we heard it was a minor wall street problem, but probably not a recession. Then it was a minor recession, but recovery was well in hand a few months into it.
I think we were many months into the recession before anyone was even talking about an economic crisis.
During Q2 2008, the Fed was fairly positive about 2008/9 GDP and unemployment.
So who knows how we will look back on this period in a few years.
I recall it completely different.
The Feds had been lowering their target rate aggressively from 5.25% in the fall of 2007. The collapse of Bear Stearns was the first big sign something was really wrong despite the Fed having lowered the target to 2.25%. Dominoes kept falling through fall of 2008, including Lehman Brothers and stock markets dropping over 25%. December 2008 was the grimmest holiday season and stocks kept dropping until hitting bottom in March 2009, having lost 50% of their value.
Not once did anyone think we had a soft landing; it was more of a hope that things didn't get worse even though everyone was preparing for the worst.
I still recall the feeling of shock and fear when Bear Stearns collapsed, knowing that this meant things were going to get a lot worse, and not wanting to return from vacation.
Fine, the surge of inflation in 2021 was largely due to the response to covid (although the Russian invasion of Ukraine in 2022 also kept the ball rolling). But no one knew whether high inflation would just go away again as the pandemic receded. We still don't know if that would have happened without some Fed action. Was the federal funds rate supposed to be kept at zero indefinitely? That nominal zero was a real rate of −5% in 2022.
As for Kevin's predicted recession, it's two years and four months later and it's still not here. What is it they say? Economists have predicted eight of the last three recessions, or something like that.
I havent seen anyone, anywhere say that rates should always be zero forever.
The Fed never knows what will happen in the future no matter what is going on at the moment. There was certainly a lot of evidence that the current inflation was temporary in 2022/23...and we cant ignore that rates are still high right now.
It's pretty standard MMT dogma that interest rates have at best a second or third rate effect if they are not actually inflationary while fiscal effects are dominant, and that paying interest on risk-free government liabilities is just giving money to people because they already have money.
Paul Krugman was a lot closer to what happened than media darling Larry Summers. What he admits her got wrong was how long inflation would last but he made his prediction before Russia invaded Ukraine which led to the big spike in gas prices. Contrary to what people claim Krugman always admits he might be wrong and why and when he is he admits it. And he doesn’t just give data that supports his predictions/analyses. He is also not wedded to an ideology, always cherry-picking data to support his case. No offense to Kevin but Krugman knows a lot more about economics.
It's always been the case that recessions start 1-2 years after the Fed hikes interest rates.
Oh for crying out loud; this is the silliest sort of "post hoc ergo propter hoc" reasoning I've seen in a long time.
You see, the economy is cyclical. It is inherently so, for all sorts of reasons. And during those cycles, the Fed raises and lowers interest rates in order to mitigate the unemployment (in the downturns) and inflation (in the upswings) that otherwise would result. But the Fed is not the only thing influencing macroeconomic cycles -- not by a long shot -- and it would be impossible for the Fed alone to "smooth out" things entirely; the forces at work are simply too great. And yes they rarely "time it perfectly" so they neither ease up on the brakes a little too early nor apply them a little too long, but anyone who says they have a crystal ball that foresees future economic conditions that accurately is simply lying.
People can argue all they want that the Fed should have eased rates last meeting instead of (pretty certain bet) next meeting, but to say that in doing this the Fed "caused" the next recession is just ludicrous.
Well stated conventional wisdom.
"...Surely nobody contests this anymore? .."
I contest it. Unless you mean COVID caused the inflation by inducing the government to over stimulate the economy.
The root cause was artificial supply shortages due to people getting sick and dying. Government "caused" inflation by pumping in money to keep people working but *not* implementing rationing or price controls which most modern economists hate. In this instance, it probably would have been the right thing to do.
Don't forget the large increase in wages. This adds to inflationary pressure, but would anyone want to lower wages back to where they were?
Wall Street !
"...but would anyone want to lower wages back to where they were?"
I would if you set prices back to where there were also.
The fact that inflation was experienced by countries around the world, even those that didn’t do much stimulus spending and our rate was not higher than everyone elses goes against the “government spending caused inflation”. From what I have read recently other countries that didn’t spend much are now looking at the US example because their economies are still struggling.
"...Government "caused" inflation by pumping in money to keep people working ..."
Sending out big checks to almost everybody had nothing to do with keeping people working. You increase demand but not supply you get price increases.
I see no reason not to believe Republican Fed Chair Powell wanted a recession before the 2024 election and it looks like he's going to just miss.
So Biden was a befuddled old fool to reappoint him, and the Democrats Biden appointed are all Quisslings?
I was worried that he would wait til after the election to lower rates because he was afraid Republicans would accuse the Fed of being political. After Monday’s dive there are now a lot of Wall Street types — hardly liberal — begging him to do an emergency rate cut now instead of waiting til September.
That's dumb. Powell isn't a total hack, like Trump would appoint these days.
"The Fed never needed to raise rates more than modestly since our recent bout of inflation was caused primarily by COVID, not a frothy market. (Surely nobody contests this anymore?)"
I agree that inflation was primarily caused by COVID, but I don't see why that means the Fed never needed to raise rates. I think you mean that COVID was primarily caused by temporary supply chain interruptions and would have resolved itself completely without any monetary action; I just don't know where your confidence on this comes from.
COVID caused LOTS of things to change. Supply chain interruptions, yes, of course, but also:
* major changes in consumer and worker behavior and preferences
* built up savings and pent up demand that people then decided to spend all at once
* lots of government stimulus
All of these things contributed to inflation.
And why do you think it would have resolved on its own? I mean, I could see how it *might* have resolved on its own, but you are so *darn* confident about that, but you've never explained it other than by stating that monetary policy has long and variable lags. And your estimate of the length of those lags has gotten ever longer, as your confidently-predicted recession has not yet come.
Remember this post?
https://jabberwocking.com/two-recessions-are-barreling-toward-us-next-year/
You predicted two recessions were coming due in 2023, saying "We are so fucked. I sure hope I'm wrong about all this." And you were! What a relief! But instead of changing your opinion, you decided that the long and variable lags were just longer and more variable than you thought.
I agree that the FOMC should have started cutting in July. But I'm disappointed that you are showing so little humility. We don't know what would have happened in a world where the Fed kept rates at 0 this whole time, we don't know what would happen if they cut rates more quickly or slowly than they actually do, and we don't know what's going to happen in the stock market tomorrow.
If this is true, isn't this a strong case that the Fed is institutionally incompetent in some deep way and needs to be gutted and rebuilt?
If they are literally incapable of raising interest rates without causing a recession, that seems like a huge problem.
The Fed may act too late or too little to get the best effects, but they are acting predictably, so we're probably okay. I'd expect a couple of 0.50 cuts and then maybe a smaller one at some point. But, they're hard to predict when it comes to those specifics.
Trump has called for a reduction, and I'm sure the Biden admin would like to see it too. There's no economic reason to NOT reduce some.
The Fed needed to raise rates simply because rates had been absurdly low for too long. Five percent interest rates with three percent inflation is not high interest. It's a real rate of 2%.
We must do something different because one should never do something for a length of time that is too long! This is not a good recipe for anything let alone monetary policy.
If rates were too low for too long, we should have seen an overheated economy. Labor markets, production capacity and supply needs all stretched beyond realistic capacities. There should be obvious signs.....
But we never saw this.
The argument that rates shouldnt be this low because back in my day rates werent this low......just never checked out very well. What you were used to back in some period when memories were made isnt very useful for policy making.
The ridiculously low interest rates produced the housing bubble.
> The Fed never needed to raise rates more than modestly since our recent bout of inflation was caused primarily by COVID, not a frothy market. (Surely nobody contests this anymore?)
It's not so much that people deny supply chain snafus (plus war in the Ukraine), but they tack on a couple of details. Noah Smith says (poorly) that about 1 percentage point of the inflation was due to the Biden stimulus. (He really means all three rounds of the Biden and Trump stimuluses, but he's really bad at communicating clearly.)
Others point out that Corporations used the cover of the supply chain inflation to improve corporate profits, generating another 3 percentage points of inflation.
And that’s just it, having rates over 1.5 over inflation tends to be inflationary in by itself due to the impact of on housing markets and capital accumulation which entrenches set companies and allows them to push higher prices due to the lack of credit and thus competition.
Higher Fed rates inject government interest payments into the private sector, and raise operating costs for business, which they try to pass on to consumers. Both of these effects may be inflationary.
That Thing Kevin Drum Is Privately Worried About (a probable recession)? It's Not a Big Deal to Kevin Drum, Publicly, Because He Doesn't Want to Come Off As Someone Who Thinks Things Are Big Deals.