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The Good, the Bad, & the Ugly

The Signal
Downturn
How bad is the American economy? Claudia Sahm on jobs, inflation, and the range of alternative near-term futures.
Lerone Pieters
Lerone Pieters
A recession in the United States is “certainly a possibility,” in the typically measured words of Federal Reserve Board Chair Jay Powell—speaking to the U.S. Congress on June 22, as evidence mounted that the country’s economic problems were getting worse than they’ve been in decades. Last month, inflation hit 8.6 percent, the most significant year-to-year increase in 40 years. The price of gasoline is now between $5 to $7 a gallon, depending on the state—an unprecedented rate in a country where millions drive long distances to work—while the costs of food and other basics are also rising steeply. Most Americans’ confidence in President Joe Biden’s ability to manage the economy is dropping, as the chances of widely expected losses for his Democratic Party in the November midterm elections are increasing. To counter inflation, the U.S. central bank, the Federal Reserve, raised its main interest rate on June 15 by 0.75 percent, the biggest hike in nearly 30 years. Average prices on the U.S. stock market, meanwhile, dropped by 20 percent this month from their most recent peak, the sharpest decline since the Great Recession of 2008-2009. What’s next?
Claudia Sahm is an economist who worked at the U.S. Federal Reserve from 2007 to 2019, including as the section chief for its Board of Governors, and was a senior economist on President Barack Obama’s Council of Economic Advisors. In Sahm’s view, a dire outlook on the American economy is understandable right now, because the financial struggles Americans are experiencing, with costs and interest rates climbing, are real and acute. Still, Sahm says, a broader view of the economy offers positive signs too, especially in the job market. The next few months could realistically play out in a number of scenarios—and while some are grim, others range to the hopeful. As the Federal Reserve attempts to cool inflation, its policies could wind up either causing Americans minimal pain or plunging the country into a severe recession. Avoiding the worst of the scenarios, Sahm says, will require some success in further containing the coronavirus, limiting the economic harm of Russia’s invasion of Ukraine, and addressing remaining challenges in the world’s supply chains. For now, though, unpredictability on all these fronts will continue to mean uncertainty for the economy.
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Michael Bluhm: What’s happening in the U.S. economy right now?
Claudia Sahm: Since Covid caused a severe global recession in 2020, the past two-and-a-half years have been one economic crisis after another. Recessions hit everyone—a recession means that a country’s entire economy goes into a downturn. Nearly everyone gets hurt financially. The industries hit hardest often take more time to recover; it often takes people longer to get jobs back in them.
The recovery from the Covid recession is halfway done. The U.S. unemployment rate is near a 50-year low—it recovered very quickly. After previous recessions, we’ve had what are called jobless recoveries, where it took a long time to get people back to work. But that wasn’t the case this time. Now we have inflation, though, with prices rising at a worrying pace—creating hardship and a lot of uncertainty—and even the smartest economists don’t know what will happen with it.
It’s not uncommon in a recovery to see this confusing mix of good and bad, but everything in the Covid crisis has been amplified in a way not seen in generations.
Bluhm: Many, if not most, economists predicted last year that inflation would be temporary—or, in economic terms, transitory. But it’s only gotten worse this year. What happened there?
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Sahm: Inflation was not transitory. I was part of “Team Transitory”; I thought inflation was going to come down. And at this time last year, month-over-month inflation was coming down. But Covid was not transitory. The Delta variant came, and then the Omicron variant came. And on top of that, now we have a war in Europe. But fundamentally, Covid not being transitory is why inflation was not transitory.
Some put a lot of blame on the American Rescue Plan, the $1.9-trillion relief package that the U.S. Congress passed in March 2021. The White House, Congress, and the Federal Reserve made policy decisions aimed at to doing more to support the economy, under the assumption that Covid was going to recede and that inflation was going to keep coming down—which, again, for a time, it did.
Today, though, I see these policies as mistakes. I advocated for them, but I was wrong too. Now, these mistakes contributed to the higher inflation we have right now, but they weren’t the cause. The causes were the Covid pandemic and then, on top of it, the war in Ukraine.
Continuing high inflation has a mix of other causes. There was an excess of consumer demand, because people had a lot more money in their hands than they had earlier in the pandemic. Economists have talked endlessly about supply chains and problems with shipping and ports, which were factors also.
There were labor shortages, as well; a lot of businesses had trouble hiring back workers. It was very unusual that millions of people dropped out of the labor force completely. They didn’t get fired; they just walked away. Many still haven’t come back. And if businesses don’t have enough workers, then they have to pay higher wages, and businesses pass those costs onto consumers.
Bluhm: To counter inflation, the U.S. Federal Reserve just raised its main interest rate by 0.75 percent, the biggest hike in nearly 30 years. But a lot of inflation is driven by rising energy and food prices, which aren’t usually affected by interest-rate hikes. How do you see this playing out? What are the possible scenarios for the near term?
Sahm: Anything could happen. There’s a lot of uncertainty. The possibilities for next year range from the good to the bad to the ugly. I see the general discussion as too focused on the ugly, though.
The Federal Reserve’s one policy tool is the interest rate. It can’t produce oil or wheat; it can’t solve the crisis in food and energy. It can’t get gas and food prices down without causing an immense amount of hardship—somewhere between the bad to the ugly.
Alex Motoc
Alex Motoc
More from Claudia Sahm at The Signal:
The good path is the most likely, in my view. On that path, the U.S. gets inflation down from 8 percent to 4 percent by the end of this year—and down further next year—without causing a recession. Unemployment might rise a little, and some might lose their jobs. But there is a path to bring inflation down and keep the labor market strong—maybe not as strong as it is right now, but strong. The bad path is that we get inflation down, but it is going to require the Federal Reserve to pull back on the money supply by raising interest rates even more—which gets people to spend less and businesses to spend less. That could put us into a recession. Unemployment would rise, people would lose their jobs, and output would slow and then decline. The bad path can play out with the recession being fairly mild—not with the 20-percent unemployment rate of the Covid recession.”
For months now, the Federal Reserve has been saying, We’re going to raise interest rates, and we’re going to keep raising them. That’s already caused increases in a lot of the interest rates that consumers and businesses encounter. For example, if you’ve been trying to buy a home, you’re not going to get a mortgage rate as low as you would have two years ago. If you’re trying to buy a car, the interest rate on your auto loan is going to be more expensive than it was. Interest rates on credit cards are going up, too. The job market is going to get tougher. Right now, the U.S. has a really strong job market. Last year, maybe you got a big raise, you found it easy to get a better job, or your kid got out of college and got a good job—all that’s going to get harder.”
The American economy isn’t in a recession. The U.S. unemployment rate is extremely low. There are two job postings for every unemployed American worker. Wages are growing; they’re not keeping up with inflation, but they are growing faster than they have in a very long time. GDP is growing at a rate that’s well above average. At the same time, there is hardship now. Gas prices are seriously high. Inflation is too high. Many people think, Recessions are bad, and we are in a bad place now, so we’re in a recession, right? No, actually. There’s a lot of bad stuff going on, it’s true; but there’s some really good stuff too, and the mix they add up to isn’t a recession. People will fear the prospect of a recession, because in a recession, millions of people lose their jobs. A recession affects almost everybody. But we’re not there.”
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