Recession Watch: Real Concerns About the Possibility

By at 16 May, 2022, 1:20 pm

Bad Policy Fuels the Likelihood


81% of small business owners expect a recession to occur this year, according to the latest CNBC|SurveyMonkey Small Business Index Q2 2022 (May 5, 2022).

by Raymond J. Keating –  

With the change in real GDP turning negative in the first quarter of this year, a question inevitably keeps popping up: Are we headed into a recession?

While the National Bureau of Economic Research (NBER) is the official arbiter of when recessions start and finish, the back-of-the-envelope definition for a recession is that the economy contracts for two consecutive quarters.

Tricky and Conflicting Data and Trends

Real GDP growth in the first quarter came in at -1.4 percent (seasonally adjusted annual rate). In our breakdown, SBE Council noted that this was a tricky set of data. There were positives and negatives after one drilled down a bit.

For example, real personal consumption expenditures, real business investment and real residential investment all grew in the first quarter. In fact, both personal consumption and business investment growth improved in each of the last two quarters, which obviously make for positive trends (albeit short ones).

The key negatives came via declines in real exports and real government consumption expenditures and gross investment, and a big drop in private inventories. As SBE Council previously noted, “While part of private investment, inventory measures are temporary. They don’t reflect long-term investment, but instead, reflect changes in consumer demand, with inventories drawn down and replenished at various times. They are transitory.” However, even if we put aside the large inventory decline, the economy still shrank in the first quarter. For good measure, big gains in inventories contributed disproportionately to the real GDP gains experienced in the previous two quarters (that is, the third and fourth quarters of 2021).

Meanwhile, notable declines in government consumption and investment for two straight quarters now seem unlikely to persist.

As for real exports, growth has been extremely erratic (with quarter-to-quarter swings back and forth between increases and declines) over the past five quarters – after big declines when the pandemic first hit and then a subsequent snapback.

And then there is raging inflation, which creates uncertainty in terms of investment, interest rates, incomes, and so on. (See SBE Council’s most recent take on inflation.)

Of course, the economy also struggles with ongoing supply-chain challenges; international uncertainties, such as regarding Russia’s war against Ukraine, questions about China, etc.; and tight labor markets. Regarding employment, the latest jobs report served up contradictory data about where the labor market was in April (See SBE Council’s analysis).

Anti-Growth Policymaking

So, after laying out this rather messy and contradictory take on the economy, we must turn to policymaking. Policies matter when it comes to the health of our economy. And the question always is: Are policies pointed in a pro-growth or anti-growth direction?

Whether looking broadly at a recovery from the pandemic and getting back on a strong growth track, or zeroing in on the investment, innovation and choices needed to alleviate supply-chain woes, or considering inflation, the need for policymaking to incentivize entrepreneurship, investment, and working should be clear.

During a time when policymakers should be debating and discussing how to provide substantive and permanent tax relief, the exact opposite is occurring with the Biden administration and this Congress.

Higher tax threats. For example, the pro-growth policy agenda should involve reducing the capital gains tax, including indexing gains for inflation in order to cut the real capital gains tax rate, in order to incentivize entrepreneurship and investment, and making permanent and improving the small business provisions in the Tax Cuts and Jobs Act, and cutting individual income tax rates, which would be a big plus for most businesses (i.e., non-C-Corp enterprises). Instead, President Biden and various Members of Congress continue to push for higher tax rates, including on capital gains, personal income and corporate income.

Imposing new costs and burdens on businesses via regulation. Deregulation and regulatory relief should be an important part of the policy agenda, including sunsetting regulations and undertaking a comprehensive review of the regulatory state in order to eliminate costly, wasteful and out-of-date regulations. Keep in mind that regulatory burdens always fall hardest on small businesses. However, the Biden administration has turned back some important regulatory reforms made during the last Administration. And this Administration and Congress continue to push for a massive expansion of regulation – including via enhanced antitrust regulatory controls – in areas such as energy, labor, technology, health care, pharmaceuticals (via price controls and undermining intellectual property protections), freight railroads, and more.

Faltering on trade. Advancing free trade – that is, reducing governmental barriers to trading – is vital for consumers, in terms of, for example, reducing prices and expanding choices; and for entrepreneurs, businesses and workers in terms of expanding opportunities in global markets, enhancing choices and reducing costs of inputs across industries, from manufacturing to retail. Yet, the Biden agenda differs little from the Trump agenda, except in tone, as each have favored protectionist measures.

Excessive government spending. Federal spending needs to be brought under control so that more resources are left in the private sector, rather than being drained via taxes or borrowing from productive private-sector undertakings guided by competition, price and profits signals, and consumer sovereignty, and handed over to elected officials and appointees to allocate such resources according to political incentives. Unfortunately, as SBE Council has noted before, if the Biden budget projections are in the ballpark, federal outlays will be running at 24.5 percent of GDP for an extended period of time. That has never happened before in U.S. peacetime history, marking a major expansion in the size of the federal government.

A fumbling Fed. Finally, monetary policy should be operated with an exclusive focus on helping to maintain price stability. Unfortunately, the Fed largely lost track of its price stability imperative back in 2008, and subsequently ran money policy so loose that it was without historic precedence. Now that inflation is running red hot, the Fed has woken up to inflation, but seems intent on trying to rein in inflation by undermining economic growth via punitive interest rate increases. That’s an old story that always comes at a big cost.

Recession a Serious Possibility

In the end, a recession certainly looms as a serious possibility – whether with negative growth continuing into the second quarter, or as a possibility a bit further down the road.

The clearest reason why the possibility of a recession has to be factored into decisions made by entrepreneurs, businesses, investors, families and individuals is primarily due to a mixed, precarious economic situation being pushed in the wrong direction thanks to misguided policymaking being imposed or threatened by the Biden administration, Congress and the Fed.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest nonfiction book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.



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