If There Is a Recession, It Has Already Happened

If There Is a Recession, It Has Already Happened

2023 doesn’t look nearly as bleak as consensus economic forecasts and financial news reports suggest.

Bob Diamond, Larry Kantor  Published on February 8, 2023

Arecession in 2023 seemed to be the consensus coming into the new year. That is no surprise, given that last year delivered the highest rate of inflation, the most monetary tightening in four decades, and an inverted yield curve. Strong January economic data—especially the U.S. employment report—may cause many forecasters to change their minds or delay the timing of an expected downturn to later in the year. But if this cycle ends up being designated as a recession, it’s already been underway for many months and will probably be over by the spring.

Recessions are typically generated by sharp declines in interest-rate-sensitive sectors, like housing and manufactured goods, and we have been experiencing that for quite some time.

Housing is clearly in a recession that began almost a year ago. Mortgage rates more than doubled, and home sales have declined for 11 consecutive months—amounting to a cumulative drop of nearly 40 percent. House prices and rents have been falling since last summer.

Consumer spending on goods in real (inflation-adjusted) terms peaked in mid-2021. This followed a surge when many services such as travel and dining at restaurants were off-limits, forcing people to spend a lot more time at home. The decline accelerated toward the end of last year following consumers re-engaging in those services and a huge rise in interest rates.

Retail sales in November and December plunged at a double-digit annual pace, forcing retailers to discount items to eliminate excess inventories, cancel expansion plans, and reduce their workforce.

That is what happens during recessions. The technology sector is also contracting following a COVID-induced boom in the demand for tech services like online shopping, food delivery, streaming services, and remote work and video conferencing. Just like the retail industry, tech companies expanded their capacity to an extent that turned out to be excessive.

Normally, all of that would be enough to crash the economy. But the COVID experience delivered several unusual developments that allowed the economy to hold up unusually well:

A combination of factors—including early retirements, less immigration, people either sick or caring for someone who is, and a dearth of childcare services—produced a massive shortage of labor. Job openings peaked at a record 11.5 million and there are still 11 million openings compared with less than 6 million people unemployed. That has allowed the economy to continue generating strong job growth even as labor demand weakens. As a result, household income isn’t getting hit nearly as hard as it usually does, mitigating the spread from the cyclical sectors to the rest of the economy.

Household and business balance sheets have remained relatively healthy, supported by huge income and wealth gains generated by unprecedented monetary and fiscal stimulus. Households were able to build up a huge stock of excess savings that they are still digging into to support spending. In addition, consumers and businesses did not take on excessive leverage and debt to the degree usually seen in the later stages of economic recoveries.

Energy and other commodity prices have fallen sharply, contrary to the experience during the great inflation of the 1970s and early 80s. The decline in gasoline and natural gas prices has boosted household purchasing power, while sharp drops in lumber and steel prices have helped keep production costs under control.

The path of the economy going forward will be determined largely by the future path of inflation and how central banks respond to it. Fed tightening is working: the cyclical sectors are getting clobbered, and most asset prices—including stock and bond prices—have fallen significantly. Most important, inflation has diminished at an extraordinarily rapid pace.

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