WASHINGTON — Whether the U.S. economy is headed for a recession became harder to answer Friday, when a report showed employers hired hundreds of thousands more workers last month than expected.
The stunning strength made it clear that the mainstay of the economy remains stable. That’s even as inflation is running at its worst pace in 40 years, the economy’s output shrank in the first half of the year and rising interest rates are dragging on housing and other industries. All the confusing numbers only make the long-term outlook for the economy murkier.
On the one hand, two consecutive quarters of economic contraction is a long, albeit informal, definition of a recession. It would mark a swift turnaround barely two years after the official end of the pandemic recession. However, can a recession really happen when so many people still have jobs and are making more money?
It’s the latest scratch on an economy that has baffled Federal Reserve policymakers and many economists since growth ground to a halt in March 2020 after COVID-19 hit and 20 million Americans were suddenly out of a job.
While most economists — and Fed Chairman Jerome Powell — have said they don’t think the economy is currently in a recession, with Friday’s data strengthening the case for many, expectations are still high that an economic downturn start later this year or next year.
Friday’s strong jobs report could actually increase the chances of a recession because it could encourage the Federal Reserve to stay aggressive in raising interest rates in order to beat inflation. Higher rates slow the economy by making it more expensive to buy homes, cars and things bought with credit cards, and the Fed is raising rates at the fastest pace since the early 1980s.
Perhaps even more important than whether a recession will occur is whether workers’ wages catch up with inflation. So far, the gains in median wages have been nonexistent, and the pain is disproportionately hitting lower-income families and black and Hispanic families. As a result, Americans have gotten worse and worse in the economy.
That may be what moves more people to the November midterm elections than whether or not a recession has officially begun.
So how do we know exactly when an economy is in recession? Here are some answers to such questions:
Who decides when a recession has started?
Recessions are officially declared by the National Bureau of Economic Research, a group of economists whose Business Cycle Meeting Committee defines a recession as “a significant decline in economic activity that spreads throughout the economy and lasts longer than more than a few months”.
The committee considers employment trends a key measure in determining recessions. It also evaluates many other data points, including measures of income, employment, inflation-adjusted spending, retail sales and factory production. It places heavy weight on jobs and an inflation-adjusted income gauge that excludes government support payments, such as Social Security.
Follow trends affecting the local economy
Subscribe to our free Business by the Bay newsletter
We’ll break down the latest business and consumer news and insights you need to know every Wednesday.
You are all registered!
Want more of our free, weekly newsletters in your inbox? Let’s begin.
Explore all your options
However, the NBER usually does not declare a recession until it has already begun, sometimes up to a year. Economists consider a half-point increase in the unemployment rate, averaged over several months, to be the most historically reliable sign of a recession. On Friday, the latest jobs report showed the unemployment rate matched the lowest level in more than 50 years.
Do two straight quarters of economic contraction equal one recession?
This is a common rule, but it is not an official definition.
However, in the past, it has been a useful measure. Michael Strain, an economist at the right-leaning American Enterprise Institute, notes that each of the last 10 times the economy contracted for two consecutive quarters, a recession has resulted.
Even Strain isn’t sure we’re in a recession right now, though. Like many economists, he notes that the fundamental drivers of the economy — consumer spending, business investment, home purchases — all rose in the first quarter.
Overall gross domestic product – the country’s broadest measure of output – fell at an annual rate of 1.6% from January to March due to single factors, including a sharp rise in imports and a post-seasonal decline in holidays in the inventories of businesses. Many economists expect that when the GDP is revised at the end of this year, the first quarter may even be positive.
“The basic story is that the economy is growing but still slowing down, and that slowdown really accelerated in the second quarter,” Strain said.
Don’t many people think a recession is coming?
Yes, because many people now feel more financially burdened. With wages rising behind inflation for most people, higher prices for essentials like gas, food and rent have eroded Americans’ spending power.
Walmart recently reported that higher gas and food costs have forced its shoppers to cut back on their purchases of discretionary spending like new clothes, a clear sign that consumer spending, a key driver of the economy, is weakening. The nation’s largest retailer, Walmart, lowered its profit outlook and said it will have to discount more items such as furniture and electronics.
And the Fed’s rate hike has caused average mortgage rates to double to 4.99%, causing a sharp decline in home sales and construction.
Higher rates are also likely to weigh on businesses’ willingness to invest in new buildings, machinery and other equipment. If companies cut spending and investment, they will also begin to slow hiring. Increased caution among companies about spending freely could eventually lead to layoffs. If the economy lost jobs and the public became more fearful, consumers would cut back on spending further.
The Fed’s rapid rate hikes have raised the chance of a recession in the next two years to nearly 50%, Goldman Sachs economists said. And Bank of America economists now predict a “mild” recession later this year, while Deutsche Bank expects a recession early next year.
What are some signs of an impending recession?
The clearest signal that a recession is underway, economists say, would be a steady increase in job losses and a rise in unemployment. In the past, an increase in the unemployment rate of three-tenths of a percentage point, averaged over the previous three months, has caused a recession to soon follow.
Many economists monitor the number of people filing for unemployment benefits each week, which shows whether layoffs are getting worse. Weekly claims for unemployment benefits, averaged over the past four weeks, have risen recently to reach 250,000. While this is a potentially worrying sign, it is still a historically low level.
Any other signals to watch for?
Many economists also monitor changes in interest payments, or yields, on various bonds for a recession signal known as an “inverted yield curve.” This occurs when the yield on the 10-year Treasury falls below the yield on a shorter-term Treasury, such as the 3-month Treasury note. This is unusual. Normally, long-term bonds pay investors a richer yield in exchange for tying up their money for a longer period.
Inverted yield curves generally mean investors anticipate a recession that will force the Fed to cut rates. Inverted curves often precede recessions. However, it may take 18 to 24 months for a decline to occur after the yield curve inverts.
For weeks, the two-year Treasury yield has exceeded the 10-year yield, suggesting markets expect a recession soon. However, many analysts say that comparing the 3-month yield to the 10-year yield has a better track record of predicting recessions. Those rates have not reversed now, although the gap has narrowed.
Will the Fed continue to raise rates even as the economy slows?
The economy’s bleak signals — slowing growth with strong employment — have put the Fed in a tough spot. Chairman Jerome Powell aims for a “soft taper,” in which the economy weakens enough to slow employment and wage growth without triggering a recession and returns inflation to the Fed’s 2% target.
But Powell has acknowledged that such an outcome has become more difficult to achieve. Russia’s invasion of Ukraine and China’s COVID-19 lockdowns have driven up prices for energy food and many US-made parts
Powell has also indicated that if necessary, the Fed will continue to raise rates even in a weak economy if that is what is needed to tame inflation.
“Is there any danger of us going too far?” Powell asked last month. “Of course there is a risk, but I would not agree that this is the biggest risk to the economy. The biggest mistake to make…would be to fail to restore price stability.”
By CHRISTOPHER RUGABER AP Economics Writer