OPINION Recession: Not if, but when
By Joseph Harris, John Locke Foundation
In reaction to an array of economic indicators pointing toward an upcoming recession, Federal Reserve Chairman Jerome Powell stated during an August press conference that the Federal Reserve would be shifting its focus from quelling inflation to promoting employment. This change in language signals a transition toward interest-rate cuts soon.
The Federal Open Market Committee (FOMC), which determines US monetary policy, has two policy objectives: price stability and maximum sustainable employment. The FOMC defines price stability as a 2% inflation rate and considers maximum sustainable employment to occur when the unemployment rate is at its “natural” rate, currently estimated at 4.4%. The natural rate of unemployment is the rate occurring in the economy when there is no cyclical unemployment; i.e., no unemployment attributable to the ups and downs of the economy.
Theoretically, when the unemployment rate exceeds its natural rate, the FOMC drives down interest rates to stimulate the economy and facilitate job growth. On the other hand, if the unemployment rate dips below its natural rate, the FOMC pushes up interest rates to cool the economy and minimize inflation.
Jobs and unemployment
Over the last year, the current administration has pointed to job-growth numbers in the establishment survey to support the claim of a strong labor market. Unfortunately, the establishment survey is misleading because the report calculates the total number of jobs on payrolls, not the number of people with jobs, and it does not distinguish between part-time and full-time jobs. This means a person hired for two part-time positions would be counted twice, resulting in exaggerated employment figures.
Furthermore, when calculating establishment survey data, BLS analysts estimate how many jobs are created at hypothetical new businesses. These numbers are not based on surveys, but on optimistic guesses. So, it should not be a surprise that the establishment survey’s initial claim that nonfarm employment from March 2023 to March 2024 increased by 2,927,000 was recently revised down by 818,000.
When questioned about the political liability that the downward job revision poses to the administration, US Secretary of Commerce Gina Raimondo stated, “First of all, I don’t believe it.” Unfortunately for Raimondo, belief is not a prerequisite for truth. Nonfarm employment figures have been revised down 15 out of the last 17 months.
The household survey gives us a more accurate view of the labor market because it distinguishes between part-time and full-time jobs and counts the number of people with jobs, not the number of jobs. Based on the survey, the number of employed people increased by just 57,000 from July 2023 to July 2024. Making matters worse, this growth was driven by increases in part-time and government jobs. During the same period, the number of full-time and private-sector jobs declined.
The figure below depicts the business cycle — fluctuations in the unemployment rate around its natural rate. When the unemployment rate rises above its natural rate, the economy is experiencing a downturn. When the unemployment rate falls below its natural rate, the economy is experiencing an upswing. From July 2023 to July 2024, the unemployment rate increased from 3.5 to 4.3%. When the unemployment rate eclipses 4.4%, it will signal the official start of an economic downturn, likely prompting the FOMC to decrease interest rates. It is worth noting that in June 2024, the FOMC projected that the highest unemployment rate for 2024 would be only 4.4%.
Housing
The post-pandemic economy was characterized by increasing home values. The median sales price of houses increased by 16.7% in 2021 and 13% in 2022, the highest back-to-back increases on record. Since the fourth quarter of 2022, however, the median sales price of houses has plummeted by 6.8%, the largest drop in a two-year period since the Great Recession.
From April 2022 to July 2024, new housing starts decreased by 32%, reaching its lowest level since May 2020. However, not only are fewer houses being built, but fewer existing homes are being sold. From January 2021 to July 2024, existing home sales decreased by 40%, reaching the lowest level since 2010.
In July 2024, the median listing price of houses was $405,933, but the median sales price was only $361,500. The high list-to-sales price ratio indicates that the housing market is experiencing a surplus. The drop in the price from listing to sales signals that the housing supply exceeds demand at the listing price, forcing sellers to lower prices to make deals.
Low-cost goods and credit cards
Inferior goods are low-cost goods that increase in demand when consumers suffer a decrease in income, such as during a recession. The Federal Reserve has noted that Walmart’s sales strength and the economy's performance move in opposite directions due to the retailer predominantly selling inferior goods. In Q2 of 2024, Walmart earned nearly $170 billion in revenue, the second-highest quarter ever for the retailer.
Not only are consumers purchasing more inferior goods, but they are also making more of those transactions with credit cards. Since 2019, the number of credit cards has grown more than 24% to 600 million. From Q1 of 2021 to Q2 of 2024, credit card debt skyrocketed 48% to an all-time high of $1.14 trillion. As of Q2 of 2024, the rate of credit card accounts newly delinquent was 9.1%, up from just 4.1% in Q4 of 2021.
Looking forward
While rate cuts will likely arrive in September, the prospect of lower interest rates jump-starting job growth enough to keep the impending recession at bay is suspect. A more likely scenario is a rising unemployment rate despite the rate cuts, met with reignited inflationary pressures. Historically, unemployment has accelerated following interest-rate cuts.
The possibility of a fiscal year (FY) 2024-25 budget adjustment is still on the table. It would be prudent for policymakers in the General Assembly to begin formulating policy solutions to address a forthcoming recession. If the state undergoes fiscal strain, policymakers should avoid tax increases or laying off teachers. Instead, the General Assembly should utilize the $4.75 billion in the Savings Reserve, $2.62 billion in unreserved cash, $2.25 billion in unappropriated funds from FY 2023-24, and the $1 billion in the Stabilization and Inflation Reserve to sustain the budget, while looking for ways to trim the fat.
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