VCU news

By Leila Ugincius

It’s Economics 101 simplified: inflation begets higher interest rates; the higher rate begets slower economic growth – maybe even a recession.

This spring, when inflation hit a 40-year high, the Federal Reserve raised interest rates to make supply and demand more balanced. At the time, talk of a recession naturally entered the conversation.

The National Bureau of Economic Research will officially decide whether the United States has experienced a recession, based on economic indicators such as gross domestic product, employment, personal income, consumer spending, retail sales and industrial production.

The last official U.S. recession was from February through April of 2020.

“Of course, that was caused by the COVID-19 pandemic,” said Christopher M. Herrington, Ph.D., associate professor of economics at the Virginia Commonwealth University School of Business. “We all vividly remember the lockdowns and business closures, which caused a sharp decline in economic activity along with a huge increase in unemployment.”

Fortunately, monetary and fiscal policymakers responded quickly and aggressively to offset the worst possible outcomes, Herrington said. On the monetary policy side, lower interest rates and active intervention in financial markets helped prevent a long-term financial crisis. On the fiscal policy side, government support in the form of stimulus payments, extended unemployment insurance, and support for businesses through programs like the paycheck protection program proved beneficial.

Collectively, these policy responses helped the U.S. economy rebound quickly and avoid a deeper, prolonged recession, Herrington said.

But is a recession now imminent?

“The Federal Reserve has indicated that it is more concerned with inflation risk than recession risk at the moment,” Herrington said. “We're likely to see interest rates continue climbing, albeit at a ‘measured’ pace because the Fed wants to avoid causing a recession while also doing its best to reduce inflation.”

One thing is certain: “There are policy tools we could use to stave off a recession for now, but we can't avoid recessions forever,” Herrington said. “We can make broad predictions based on past experiences, but it is incredibly difficult to say ahead of time exactly who will be affected and how.”

Herrington spoke with VCU News about the chances of a recession and what a recession could mean to you.

Very simply, what is a recession?

A recession is a significant, widespread decline in economic activity lasting for at least several months.

How often does the U.S. experience a recession? What are some of the major historical recessions we've gone through?

The U.S. business cycle — the fluctuations in GDP over time, which includes recessions and expansions — has changed a lot over the long run. If you look at the entire history of official recessions dating back to 1854, the average time between recessions was less than five years. However, this long-run average is dragged down by the fact that recessions occurred more frequently in the late 1800s and early 1900s. Since World War II, the U.S. has experienced recessions about every six years, on average, and since the mid-1980s that has increased to nearly 10 years.

How has the country rebounded from these previous recessions?

I think a big reason that we saw such a strong public policy response during and after the COVID-19 recession was because of lessons learned during the so-called "Great Recession," which began with the financial crisis in December 2007 and lasted 18 months through June 2009. Unlike the quick recovery we experienced after the COVID-induced recession, the Great Recession was followed by a very long and slow recovery. It took about five years, in fact, for GDP per person and employment to return to their pre-recession levels.

Are we headed for a recession now? How did we get here? What are the signs?

It's impossible to say with certainty whether we're on the cusp of another recession, and right now there is a lot of mixed evidence. For example, Bloomberg conducts a regular survey of economists, and their latest results indicated a nearly 50% chance of a recession within the next year. That is up from about a 20% chance in March. The fact that GDP has decreased for two consecutive quarters is not a promising sign.

Moreover, inflation is quite high and the Federal Reserve is raising interest rates aggressively to bring inflation back down toward the 2% target. This monetary policy action is going to continue tamping down investment activity, which is an important component of current GDP and a big contributor to growth going forward. But on the positive side, the labor market continues to look quite strong. The economy added more than half a million jobs in July, and the unemployment rate remains near record lows. Plus, real consumer spending has continued to grow. So yes, certainly there are risks for the U.S. economy right now, but there are also many positive signs. A recession in the near future is not a certainty.

Is there something individuals can do to shorten/lessen the extent of the recession?

There's not much that you or I can do to affect the macroeconomy. We're a country of 330 million people generating more than $20 trillion of annual economic output, so each individual is only a tiny part of this vast socioeconomic machine.

Who is most affected? What can Joe Citizen do to ‘weather the storm?’

Recessions can certainly have very different impacts on various sectors of the economy, as well as on different groups of people.

As an example, think about durable consumer goods which can be used for a long time — things like cars, furniture, appliances and electronics. If the economy enters a recession and people are worried about losing their jobs, we can often delay these purchases until times improve.

On the other hand, think about nondurable goods like food and gasoline. We tend to purchase these more frequently and with less regard to macroeconomic conditions, so the durable goods sector exhibits much larger declines during recessions and much larger booms during expansionary times compared to nondurable goods.

One consequence of this is that workers and business owners in more volatile sectors can face greater risk of unemployment or income loss during recessions compared to those in less volatile sectors. Similarly, when we think about characteristics that can vary across workers — like education or job experience — it tends to be the case that recessions have a greater negative impact on lower educated and less experienced workers who have less job security.

The fact that recessions can have such varying impacts across different workers in different sectors makes it difficult to generalize about Joe Citizen. For some individuals, recessions pose little risk and will have little impact on day-to-day life. But for others, a recession can be financially devastating and leave a lasting impact. Fortunately, we have a pretty robust social safety net, which will help many people weather the storm, but there are also people who slip through the cracks for various reasons.

When we talked about interest rates back in May, you mentioned that consumers who have assets in saving accounts, certificates or treasury securities may benefit from higher interest rates as the returns on those investments increase. What happens to those assets if a recession hits?

The returns on these kinds of accounts will be closely tied to monetary policy. If the Federal Reserve continues raising interest rates, then the nominal return on these accounts should also continue to rise. However, it's important to note that high inflation is also going to continue eating away at the real returns: the future purchasing power of these assets. This means savers will also be relying on the Fed to rein in inflation, or else the real value of their savings will be eroded despite earning higher nominal returns.

Should we modify our saving/investment plans during this time? What's the best way to utilize our resources?

I wish I had a crystal ball and could tell you exactly which investments are going to perform well over the next few years. Unfortunately, it is incredibly difficult, perhaps impossible, to time your investment strategies to "beat the market" regularly and consistently. I think the best advice that economists have for ordinary savers is to keep it simple. Set up automatic savings through paycheck deduction that goes into low-cost, well-diversified investments like index funds. These aren't the most exciting investment vehicles, but they perform well over the long run, and the strategy avoids the risk of losing money from trying to pick winners or anticipate market fluctuations.