OPINION: Our recent research suggests there is a significant likelihood of a recession in the not-too-distant future. That’s because high inflation and low unemployment are both strong predictors of future recessions.
With inflation surging to a new 40-year high and continuing to accelerate, the Fed is expected to lift interest rates by a half-percentage point at the end of its next meeting on Wednesday.
Today, inflation is at 8.5% and unemployment is at 3.6%—suggesting a recession will be very hard to avert.In the short run, the supply of goods in the economy is more or less fixed—there is nothing that fiscal or monetary policy can do to change it—so the job of the Fed is to manage total demand in the economy so that it balances with the available supply.
The resulting increase in borrowing costs can help slow economic activity by discouraging consumers and businesses from making new investments. But it would come at the risk of causing major economic disruptions and pushing the economy into a recession. This is the soft landing: Interest rates rise and demand falls enough to lower inflation, but the economy keeps growing.
In all three episodes, the Fed was operating in an economy with significantly higher unemployment, lower inflation and lower wage growth. In these historical examples, the Fed also raised interest rates well above the inflation rate—unlike today, where inflation is at 8.5% and interest rates are projected to remain below 3% through 2023—and explicitly acted early to pre-empt inflation from spiraling, rather than waiting for inflation to already be excessive.
In a sense, wages are the ultimate measure of core inflation—more than two-thirds of business costs go back to labor—so rising wages put significant upward pressure on inflation. Wage growth today is running at a historic rate of 6.6% and accelerating. In our assessment, the inflation problem facing the Fed today is substantial and unlikely to be resolved without a significant economic slowdown. Overall, the combination of an overheating economy, surging wages, policy delay by the Fed and recent supply shocks means that a recession in the next couple of years is certainly more likely than not.Lawrence H. Summers is the Charles W. Eliot University Professor at the Harvard Kenney School and was U.S. Treasury secretary from 1999 to 2001.
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