Why the next recession won’t be like 2020 — or 2008

Some financial institutions, executives and investors have declared that a recession is a major risk, with some outright predicting one at least by the end of next year.

Recessions are on the mind for a few reasons. For one, the economy is, technically, contracting. The Federal Reserve is also doing its best to bring down inflation — running at the highest rate since the early 1980s — by raising interest rates. But at the same time, consumer demand is remarkably strong, with retailers hammered by high costs and inventory issues still reporting brisk business and personal finances remaining quite strong.

“Is a recession imminent? My answer is no. This doesn’t look like an economy that’s shrinking,” said Guy Berger, principal economist at LinkedIn, referring to the persistently strong employment data.

At the same time, the financial markets are clearly telling us something about the economy. The S&P 500 is down over 18 percent this year, while the tech-heavy Nasdaq is down almost 30 percent, one of the most dramatic drawdowns in history.

What is the market telling us that the employment numbers aren’t? The divergence might be because markets and the “real economy” operate on different timescales. Employment and consumer spending data can be strong now while markets reflect what future economic conditions, especially the Federal Reserve’s interest rate hikes, will do to corporate earnings.

“It’s unusually hard to know right now because we’re experiencing so much economic change as a consequence of coming out of the pandemic. The economy is changing more every quarter than it typically does every year,” said Michael Strain, director of economic policy studies at the American Enterprise Institute. And that’s just the internal dynamics of the U.S. economy — there’s also the effects new covid waves, domestically and especially in China, can have on global production and demand, as well as shock to energy and food markets from the Russian invasion of Ukraine.

Beyond any given economic statistic, there’s a deep sense of unease in the economy — measures of consumer sentiment are low and, according to Pew, 70 percent of American view inflation is a major problem. And for many Americans, especially workers who came into the economy during the 2008 financial crisis, the obvious reference point for an unwell economy is a wrenching recession.

But while there are few more dangerous words in economics than “this time is different,” it may not be the case that a downturn is inevitable or, if it arrives, that it will be an economy-wide cataclysm. The U.S. may be better equipped for a possible recession than it was in the 2000s. It’s not so much that this time is different, but historically speaking the next recession could be more typical.

Why (some) experts say a recession is due

The Federal Reserve is doing its best to cool down a red-hot economy, but it’s tricky to get that cooling right without causing a downturn.

Strain, a persistent critic of the fresh round of stimulus spending from the American Rescue Plan, told Grid he was “pretty worried” about a recession in the next year and a half, citing a risk of the “economy collapsing under the weight of these high prices,” alongside the risk that the Federal Reserve’s efforts to cool off inflation leads to a downturn.

There’s some data indicating that businesses are worried about a downturn, like a recent survey by the Federal Reserve Bank of Philadelphia of manufacturers hitting its lowest level since 2016, and some technology companies which have been hammered by stock price declines have announced layoffs, like Netflix and Carvana, while the investors in some privately traded companies have marked down their value. And after almost two years of complaints about labor shortages, some large employers, like Amazon and Walmart, have said that they’re actually overstaffed.

“There’s no way we don’t experience a severe growth slowdown and likely a recession,” Amberwave Partners co-founder Stephen Miran told Grid, based on his analysis of the effects the Federal Reserve’s rising interest rates and reduction of its hoard of bonds will have on the market. “Because of the speed of this tightening cycle, we’re probably going to see the recession show up with a much tighter lag than normal.”

And Berger is starting to see some signs that small and medium-sized businesses are slowing down their job posting, even though he hasn’t seen any indication that hiring is down overall.

But not all recessions are the same

It may not even be obvious when or if the economy enters a recession until after it’s begun, unlike in dramatic downturns in 2007 and 2020. “The last two downturns have been depressions, in a typical recession … we’re debating whether we’re in a recession,” Strain said.

But if a recession were to come, it may not look like the Great Recession or a once-in-a-century pandemic. That’s because it would be a recession induced by the Federal Reserve, not one caused by a massive blowup or wrenching stop to the economy.

Miran anticipates a so-called garden variety recession, contrasted especially with the 2008 recession where household finances took a dramatic hit thanks to tanking home values compared to high outstanding debts. Right now, however, many Americans’ personal finances are in good shape, even if they’re being battered by inflation.

Thanks to stimulus payments and low unemployment, many households have savings, income and what financial assets they own — whether home equity or stocks — that are likely more valuable than they were before the pandemic.

Strain said a downturn would likely mean a less dramatic rise in the unemployment rate than in past recessions and perhaps much of the cooling off the Federal Reserve is seeking could be achieved not through layoffs but, instead, through employers simply listing fewer job openings.

The 2008 recession, which started in housing and radiated outward, absolutely hammered household and corporate balance sheets and led to a sluggish recovery that took more than seven years to reach the pre-downturn unemployment rate.

“It took households and businesses years to deleverage because they’ve taken on bad debt,” Miran said.

This time we hope it’s different.

Thanks to Alicia Benjamin for copy editing this article.