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Worrying About the Next Recession

As the economic recovery drags on in excruciatingly slow fashion, one thing should concern the country: we’re in no position to handle another economic shock. Just as a family overburdened by mortgage debt would be ill-equipped to withstand an economic blow like sudden unemployment or a medical catastrophe, a country with a too-high unemployment rate and low economic growth at the baseline could not deal very well with a new recession. Ben Bernanke expressed this well at his press conference last week when he said that his monetary policy tools wouldn’t be able to offset the contraction that would result from the fiscal cliff.

Tim Duy puts this another way. Interest rates are currently at the zero lower bound, and the Federal Reserve’s forward guidance indicates that rates are likely to remain there until mid-2015 at the earliest. At that point, it would be six years since the end of the previous recession:

June 2015 would mark 90 months since the peak of the last business cycle in December 2007. The average peak-to-peak cycle of the last three recessions 96 months, the average since 1945 is 66 months. Now, I don’t think you can say that the probability of recession in the next month is a factor of the time since the last recession. But you can say that given past business cycle timing, it is perfectly reasonable to believe that the next recession will hit before we lift off the zero bound. Moreover, it would be relatively uncommon for the peak-to-peak cycle to last more than 90 months. Only 4 of the last 11 cycles have exceeded this length of time.

So I am getting a little nervous that we will not lift off from the zero bound before the next recession hits. Or maybe the attempt to lift the economy off the zero bound is the trigger of that recession. In either case, I am thinking it would be very bad to be still at the zero bound when that recession hits.

We don’t have to have recessions every six years. But the historical data indicates that we will, whether due to the business cycle or simple policy missteps. And because it has taken so very long to return the economy to normal health after the Great Recession, we will be in a really disadvantageous position when that next recession hits, possibly as early as next year if the fiscal cliff turns out badly. Unemployment could be at 7 or even 8% when the next recession comes. How high will it rise? Interest rates could be at zero with nowhere to go, and we could be in the midst of the more unconventional easing policies designed to deal with that scenario. How do you double down on the double-down? Not to mention the fact that we have the same banks with the same problems of size and risk, which could be exposed by a new recession.

And, the combination of a Republican Party that no longer believes in stimulus and a Democratic Party that won’t defend it means that the fiscal tools, which are much more robust to deal with recessions, may not even be tapped when the next recession comes.

This next recession could be on us in a hurry. We’re in the midst of a global slowdown, not only in Europe but, more important, in China and the emerging markets. The fiscal cliff will require an incredibly delicate hand, when our politics demands a blunt instrument. At least some fiscal contraction will ensue from that resolution, and maybe a lot.

If you thought this recovery was bad, in other words, wait until you see the next one.

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David Dayen

David Dayen