This is from a speech given by Tom Barkin, president of the Federal Reserve Bank of Richmond, at the Montgomery County Chamber of Commerce in Blacksburg, Virginia, in August 2023. 

Today, I want to speak about the economy and where we may be headed. I caution you these are my thoughts alone and not necessarily those of anyone else in the Federal Reserve System.

I look forward to your questions at the end, but I will start with the number one question I’ve been hearing, which is:

“‘Are we headed into a recession?’ I would caution you that no one canceled the business cycle, so one can never fully rule out a recession — it’s just a question of timing. But I get why the concern might be elevated today. Fiscal support from the pandemic is waning and … inflation is moving the Fed to increase rates. … Those who look more closely for signals may be pointing to … the yield curve, a closely watched recession predictor that has predicted eight of the last seven recessions.”

Now, what makes forecasting a recession so hard is that the question never seems to go away. In fact, the response I just gave comes word for word from a speech I gave last summer. I know it’s a bit self-referential to quote yourself, but it’s telling that we are having the same conversation over and over again.

This has been called the most predicted recession in memory. Forecasts keep getting pushed out. For example, in a November 2022 Bloomberg economist survey, the median respondent expected a recession in the first quarter of this year. In January, that got pushed to the second quarter. In May, it was the third quarter. The Conference Board’s Leading Economic Index, historically a credible indicator, has been deteriorating and therefore predicting a recession, over each of the last 15 months.

A resilient economy

But a recession hasn’t happened, even though the Fed has raised rates 525 basis points over the last 17 months in an effort to fight inflation, which is now in the 4 percent range. GDP remains solid, growing 2.4 percent in the second quarter, in no small part thanks to the consumer. Higher-income consumers are still spending, and higher wages are supporting consumption, too. The labor market has also remained remarkably resilient, with the unemployment rate at a historically low 3.6 percent. We have added nearly 1.7 million jobs and 2 million people to the labor force thus far this year.

So, why haven’t we seen a recession? I think it’s because the pandemic is still with us — not the public health crisis, thankfully, but the economic dislocation it unleashed.

Businesses experienced severe shortages over the last few years. So, they tell me they are holding on to workers and investing in safety stock. More fundamentally, they are still seeing healthy demand from their customers, and working through order backlogs. And manufacturing and construction are seeing a boost from coming government investments in infrastructure and the like. If your business is healthy, why cut back?

At the same time, consumers continue to spend, funded by excess savings accrued during the pandemic, elevated equity and housing wealth, and a robust jobs market. This year, the drop in gasoline prices has freed up additional spending capacity. In June, the Transportation Security Administration hit a new daily record for number of passengers screened. “Barbie” grossed $162 million in its first weekend. Taylor Swift is on a billion-dollar tour. Consumer spending is 68 percent of the economy and, while weaker, is still far from weak, as was shown in the most recent strong retail sales report.

You might still ask: Well, how about now? Are we finally going to experience the recession everyone has been predicting? Well, we will someday. As I said up front, no one banished the business cycle, so those who keep predicting a recession will eventually be right.

But most recessions come suddenly. Remember the pandemic or the global financial crisis. Unexpected shocks cause consumers and businesses to pull back in unison. For sure that could happen here; imagine, for example, a cyber shutdown. I’m not going to try to make a prediction on the unexpected.

The inflation fight

But I usually get the recession question these days due to a fear that the Fed’s commitment to reining in inflation will be that shock to the economy. Inflation remains too high. And if there is one thing we have relearned over the past two years, it is that inflation is painful, and everyone hates it. They hate the uncertainty. They hate that it feels unfair. And frankly they find it exhausting.

Our efforts to address inflation arguably have pushed several industries into mini recessions already. Interest-sensitive sectors like housing and manufacturing have slowed. Commercial real estate (particularly office) is challenged. Banks have experienced turmoil. And those with lower incomes are trading down and slowing spending as their savings are drawn down.

Further slowing is almost surely on the horizon. A number of pandemic-era fiscal support programs are ending. Rate increases work with a lag; many models estimate their impact should start to really hit around now. In addition, as banks preserve liquidity and protect earnings by stepping back from marginal lending, credit conditions have tightened, reducing consumer and business spending capacity.

Worth watching: Will this slowdown be different?

No one wants a recession, but it’s worth remembering that not all recessions are created equally. We’ve been scarred by our memories of the Great Recession and the Volcker Recession, but they were particularly long and deep.

As I talk to firms, I hear reasons to believe that — if a recession were to occur this time — it might be less severe.

It could cause less dislocation in the labor market. When you think of a slowdown, you naturally think of 2008 when manufacturing workers were sidelined across the Rust Belt and those last into the workforce bore a disproportionate burden. But those are the workers I hear are most in demand today, as manufacturing plants, hotels, construction sites and restaurants remain short of workers. Recent large company layoff announcements have targeted administrative functions, not front-line workers. These professionals may have a lower propensity to file for unemployment, be unemployed for shorter periods and often can leverage backup savings to bridge their consumption. Unemployment for those with a college degree runs at 2 percent.

A spending slowdown could be mitigated by latent demand. Houses and cars became expensive and hard to find. But should supply open up in a weakening economy, I suspect we would find a number of buyers who have deferred purchases over the last few years and are ready to spend.

And the prolonged recession preamble we’ve seen could reduce the cost. Businesses planned last year and are planning this year for a recession. They have slowed hiring, streamlined costs, managed inventory levels, and deferred investment. Banks have cut back on marginal loans. Many consumers have tightened their belts. So, if a recession does come, the economy should find itself less vulnerable. And if it doesn’t come, today’s conservatism can fuel tomorrow’s revival. You might even argue that the recent strength in the economy is being supported in part by businesses, consumers and governments that have outperformed their recessionary forecasts. These windfalls may be lifting consumer sentiment too.

Finally, of course, there is still a plausible story that inflation normalizes in short order and the economy dodges additional trauma. There has been a lot of talk over the last few weeks about the potential for what is often called a “soft landing.” Certainly, last month’s inflation read was a good one and I hope it is a sign. To be sure, the Fed’s objective is not to cause a recession; it’s to reduce inflation, in line with our mandate. We learned in the ’70s that if you don’t get inflation under control, it comes back even stronger.

Tom Barkin is president of the Federal Reserve Bank of Richmond.