To be clear, a recession is never good. People lose their jobs, companies go out of business, assets fall in value, uncertainty spreads. But some recessions are worse than others. The 2001 recession was fairly mild and short, with the unemployment rate peaking at 6.2%. In 2008, it rose to 10%, while households saw much of their wealth destroyed and the recovery dragged on for nearly a decade.
Three things determine how bad any recession will be: what the economic conditions were going in, what caused it, and what the policy response is. It’s worth taking each in turn.
The current economy is in pretty good shape. In contrast to 2008, households are not over-levered. They are more capable of weathering a contraction, or even a period of joblessness. If there were a recession, demand would fall — but not crater. Corporations are not excessively levered either, at least when it comes to public debt markets.
BloombergThis relatively low debt level — much of it locked into low rates — suggests a fair amount of resilience in the economy, even if economic conditions worsen.Granted, there are serious long-term sources of weakness: too much government debt, an economic policy insufficiently focused on trade and growth, political instability and a broken immigration policy. But unless America is unlucky, it has several years before these have a big impact on the economy.How about the second factor: What causes a recession? Sometimes it is a big supply shock, such as shutting down the economy for a pandemic or a huge spike in the cost of energy — neither of which is expected. In the 20th century, some recessions came from an overly tight monetary policy. And despite the complaints that the Fed did not cut last week, rates are still not that high by historical standards — and it is not clear that financial conditions are even tight right now.
BloombergIf a recession does come, the likely cause is the end of the post-pandemic overexuberance, which is epitomized by a stock market juiced on AI hype. If a recession is caused by an AI-induced market correction, that suggests a recession more like 2001’s than 2008’s, which was more about problems in the debt markets than with equities.
The final factor is the policy response. Austerity and a tight monetary policy can make a recession much worse — just as expansionary policy can speed a recovery and make a recession less bad.
Odds are, there will be expansionary policy. The Federal Reserve has a well-developed playbook to go into expansion mode once a serious weakness emerges in the macro economy or there is a serious liquidity event. In some ways the current volatility is reminiscent of 1997, when the foreign-exchange market also set off global instability. But a financial crisis was avoided in the US because the Fed helped arrange a buyout of Long-Term Capital Management, a large hedge fund whose fixed-income positions threatened a major liquidity event.
Fiscal policy in either a Donald Trump or Kamala Harris administration will probably also be loose, since neither appears to fear debt. That does raise the risk of an overly accommodative policy reigniting inflation, which still is higher than the Fed’s target. But policymakers can argue about crossing that bridge when they come to it.
Expansions don’t die of old age, as the saying goes. At the same time, the markets have been waiting for a recession since at least the re-emergence of inflation in 2022 — perhaps because they viewed a soft landing as unlikely, maybe because they saw the record-setting US economy as unsustainable. Even if they’re right, there are reasons to expect any recession to be relatively mild and short.
