The ‘recession cure’ divides economists

At the heart of the debate among economists and policymakers is a fundamental question with massive implications for America’s future: What is worse – inflation or a recession?

No one seems to agree one way or the other.

But many economists and lawmakers are pushing back on that idea, arguing that the so-called cure for a recession would be far worse than the disease of inflation.

To be sure, the Fed would like to avoid both. It aims for a “soft landing” where it raises interest rates from juuuust enough to slow demand without suffocating it completely. That would be the ideal outcome, although the Fed itself admits that the prospect of sticking to the landing is becoming increasingly difficult.

“The Fed’s actions to date do not guarantee a recession, but they have already made one more likely,” Josh Bivens, the research director at the left-leaning Economic Policy Institute, wrote in a blog post earlier this month.

That leaves us with two potential outcomes: More inflation of the kind we’ve seen over the past year, or a recession that drives prices down while likely raising unemployment and depressing wage growth.

Team Inflation

Bivens is firmly in the “high inflation is bad, but a recession is worse” camp. That’s largely because of what a recession does to the job market. “A recession actually means your economy is worse on average,” he told CNN Business.

Inflation is obviously eating away at people’s wages, and that’s a bad thing. (Consumer prices rose around 9% last month on an annual basis, while wages rose 5.3%). But, says Bivens, “the one thing we know about recessions is that they drive down wages much more reliably than inflation does.”

One of the main arguments his opponents make is that inflation comes with a sticky psychological problem. Only when idea of ever-rising prices becoming embedded in the consumer’s psyche, it can create a self-fulfilling cycle that is difficult to break. It’s no joke, says Bivens, but in his estimation we’re simply not there yet.

In the United States, inflation has remained stable at around 2% a year for the better part of four decades. Because of that, he argues, people largely don’t expect recent inflation of around 9% to stick.

“We should take advantage of that expectation and that credibility,” he says.

Senator Elizabeth Warren is another prominent voice in this camp, arguing that the root cause of our current inflation—including supply chain chaos caused by the pandemic and the war in Ukraine—lies far outside the Fed’s jurisdiction.

Higher interest rates won’t fix skyrocketing energy prices, Warren wrote in a Wall Street Journal op-ed last week, and “they won’t break up the corporate monopolies that Mr. Powell admitted in January could be raising prices because they can .”

When the Fed raises interest rates, it makes it more expensive for people and businesses to borrow money. It makes everyone spend less. Companies are cutting back on hiring, reducing hours or laying off workers as demand dries up.

That, Warren writes, “will leave millions of people — disproportionately lower-wage workers and workers of color — with smaller paychecks or no paychecks at all.”

Stock recession

Others argue that recessions, while also not ideal, are not necessarily catastrophic. The may even be healthy.

Many who would argue for a recession due to inflation point to the 1970s, when headline inflation soared and peaked at 14% in 1980. It took painful interest rate hikes and two successive recessions in the early 1980s, overseen by then central bankers Paul Volcker, to finally break the cycle of inflation.

“A mild recession now is far preferable to the severe, Volcker-like recession that will be needed to curb inflation if expectations stick,” economist Noah Smith wrote in a blog post.

Not all recessions are created equal. The United States has gone through 34 recessions since 1857 — or about one every five years on average, according to data from the National Bureau of Economic Research. On average, each lasted about 17 months.

That means the US has pulled out of many recessions.

“People tend to forgive mild recessions, but they get really, really up in arms about high inflation,” Smith writes in a Substack post titled “Yes, We’re Probably in a Recession, and That’s OK.”

But can a recession ever really be a good thing? Sometimes, says Lakshman Achuthan, co-founder of the Economic Cycle Research Institute, which determines recession dates for 22 economies around the world.

“Recessions can be cleansing events for the economy as a whole, forcing inefficient giants out of business and making room for more nimble competitors who can better meet customers’ needs,” he said in an email to CNN Business. “This time, the economy has changed enough after the pandemic that new business opportunities must have opened up.”

Achuthan points to some of the innovative businesses that emerged during recent downturns: Airbnb (founded in 2008), Uber and WhatsApp (founded in 2009) all emerged from the Great Recession of 2007-09.

The bottom line

Whether or not the US is in a recession now is largely a semantic debate. There are signs that the economy is cooling – demand for housing is slowing and consumer confidence is on the way.

In most recessions, federal stimulus is a typical way to stimulate the economy and restore consumer confidence. These financial lifelines are not as likely to land this time.

“If the narrative becomes, ‘we had to have a recession because we spent too much in 2021,’ you kind of suspect that no relief is coming,” Bivens says. “I just think it’s a mistake all around.”

—CNN Business’ Jeanne Sahadi contributed reporting.

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