Is America heading into a recession? Rising inflation, stagnant economic growth, and dramatically falling stock values suggest yes. But the continued job gains suggest that the economy is steadfastly holding off a decline.
Specifically, the economy added 372,000 jobs in June, holding the unemployment rate at 3.6% — just 0.1% away from tying the lowest level in 52 years. Job growth has leveled off at a pace that would come to 4 million annually, and employers report 11.3 million job openings, which is nearly double the 5.9 million Americans actively seeking work.
At the same time, the gross domestic product (GDP) declined in the first quarter, and is forecast by some to decline again in the second quarter. While the panel that classifies recessions examines multiple economic variables, each past instance of two consecutive quarters of declining GDP has been classified as a recession. How do we square the declining GDP and rising jobs data?
One possible explanation is measurement error. For instance, the Gross Domestic Income (GDI) is continuing to expand, which should also mean a growing Gross Domestic Product because an economy’s income should equal its spending. Any downward revision of the current inflation rates would also show stronger real economic growth. Another possible explanation suggests that soaring consumer demand from trillions in Federal Reserve money creation and federal “stimulus” payments is still winding through the economy and merely delaying the inevitable recession.
It may also be the case that productivity has plummeted. Indeed, if an economy adds millions of new workers while producing less output, it must mean that output-per-worker is declining. Economist Jason Furman estimates that productivity growth may have declined as much as 6% annualized thus far in 2022, which would well exceed previous productivity declines.
Furman acknowledges that productivity data is noisy and subject to significant revisions, and that it is too early to determine the drivers of such a productivity decline. Some of the drop may simply be a reversal of the productivity surge that occurred during the pandemic. It may also be that the “great resignation” moving many workers into new careers is causing some transitional productivity adjustments. Employers may be hoarding workers in a competitive job market. It is too early for definitive conclusions.
Nevertheless, as long as inflation remains elevated it will bring economic pain, dislocations, and possibly a recession. Lawrence Summers notes that “over the past 75 years, every time inflation has exceeded 4% and unemployment has been below 5%, the U.S. economy has gone into recession within two years.” Today’s figures of 8.6% and 3.6%, respectively, meet those criteria.
The Federal Reserve’s challenge is to raise interest rates and unwind its balance sheet enough to choke off inflation without grinding the entire economy to a halt. Its tools are blunt instruments that make threading this needle quite difficult.
However, the Biden Administration and Congress have anti-inflationary tools that are less economically damaging and thus could take pressure off the Federal Reserve. For instance, the Peterson Institute for International Economics calculates that even a 2-percentage point reduction in tariffs could lower inflation by 1.3 percentage points and save $800 per household. The White House can also pare back inflation by abandoning its push to expand Buy America rules, Davis-Bacon rules mandating above-market wages, ethanol blends in gasoline, and environmental restrictions on building infrastructure. Perhaps most importantly, the White House should lift restrictions on oil, coal, and natural gas exploration, and finally abandon its proposed Build Back Better tax-and-spending extravaganza.
These policies would bring down inflation and thus allow the Federal Reserve to use a softer brake pedal. Many of these policies would also increase economic productivity, which is a free lunch that expands the economy typically without adding to inflation. In fact, if declining productivity is indeed dragging down economic growth, then such pro-growth policies become even more vital. This includes more broadly streamlining the regulatory burden, encouraging investment, and avoiding tax increases.
With inflation still elevated, the diverging economic growth and jobs data suggest a teetering economy that could go either way. Congress and the Administration must use their tools wisely and not simply wait on the Federal Reserve to slam the economy’s brake pedal.
Brian Riedl is a senior fellow at the Manhattan Institute. Follow him on Twitter @Brian_Riedl.