SYNOPSIS: A recession is possible, but only because of bad monetary luck.
Back when Jimmy Carter was president, his anti-inflation czar, Alfred Kahn, was chastised for his excessive frankness when he spoke about a possible recession. So in subsequent speeches he referred to the threatened event as a "banana."
Well, some people are doing their best to turn us into a banana republic; are we also about to turn into a banana economy? The answer is a definite maybe.
The long boom of the 1990's made many people forget a fundamental truth: the course of economic expansion never did run smooth. Alan Greenspan and his colleagues try to keep the economy on a steady course. But the Fed can never be sure either how much effect a change in interest rates will have or how long it will take for that effect to occur. So managing the economy is like trying to drive a car whose brakes have an uncertain and delayed effect on its speed. You have to expect an occasional sudden slowdown.
For more than a year the Fed has been tapping on those brakes, trying to slow an economy that it thought was growing too fast. Until a few weeks ago the higher interest rates didn't seem to be having much effect. Now there are signs that consumers are feeling cautious, a state of mind that isn't helped by the plunge in tech stocks. Meanwhile, low stock prices and high interest rates on corporate bonds are cramping business investment. So now it seems that the Fed may have stayed on the brakes a little too long.
If the economy slows too much the Fed can, of course, push interest rates back down. But like the rate hikes, any rate cut will have an uncertain and delayed effect. So there's a pretty good chance that the months ahead will see a slowdown severe enough to cause a rise in the unemployment rate. Whether that slowdown will be sharp enough or sustained enough to meet the technical definition of a recession — at least two quarters of actual economic decline — is more doubtful, but it's certainly a possibility.
But even if we do have a recession, so what? A brief recession might come as a shock to those who thought the laws of economic gravity had been repealed, but it needn't do any lasting harm. In 1990-91 we had a recession that, like the possible recession in our future, was basically a fumble by the Fed — in other words, it didn't reflect any fundamental problems in the economy. Recovery was unusually slow, in part because of the side-effects of the savings and loan crisis, but even so the recession left few lasting scars and barely registered on the long bull market.
Admittedly, the recession before that — the double-dip slump from 1979-82 — was a much more wrenching affair. But that recession took place in an environment of runaway inflation, where getting prices under control took priority over a quick recovery. It's hard to see any parallel in our current situation.
If you want a parallel to worry about, it comes not from our own experience but from that of Japan. The world's second-largest economy went into a recession at the beginning of the 1990's and has never really gotten out, despite a series of interest-rate reductions that eventually brought short-term rates down to zero. And Japan's crisis followed an era of irrational exuberance that in some ways resembles the late 1990's in the U.S.: a period of vigorous growth, overweening national self-confidence and extremely high stock prices.
While there are some disturbing parallels between America now and Japan a decade ago, there are also important differences. U.S. stock prices never got as high compared with earnings as those in Japan, and we haven't had anything like Japan's real estate bubble. Japan's problems in getting a recovery going have also been aggravated by special national issues, like extremely conservative consumers and a rapidly aging population.
But aren't plunging tech stocks in effect predicting a severe recession? Maybe so — but why would you believe that prediction? If the wild tech optimism of last spring didn't herald an unprecedented economic boom, the market's new pessimism needn't herald a looming slump.
So will we have a recession? Maybe. If so, will it be severe and prolonged? Not likely. And the best news of all is that the Fed will be able and ready to react, whoever is or isn't president.
Originally published in The New York Times, 12.3.00