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A ‘devastating’ recession is not likely, former Fed governor says


A U.S. recession this year or next is looking incredibly likely, but Americans can rest assured that the worst-case scenario of a “devastating early 1980s-type recession” probably won’t come to pass.

That is the take of Randall Kroszner, a former member of the Federal Reserve Board of Governors and a current professor of economics at the University of Chicago’s Booth Business School.

Between the rapid rise in interest rates from the Federal Reserve to combat inflation this year and a cloudy global macroeconomic picture, a recession is looking increasingly inevitable to market watchers, who have recently priced in the chances of a mild recession this year at 80%, according to Bank of America strategists.

The question on everyone’s mind now is whether an eventual recession will be “mild,” marked by only a slight uptick in unemployment and a manageable downturn in economic growth, or whether it will be more serious.

Investors are pricing in the chances of a severe recession at 30%, according to Bank of America, and last week, Sen. Elizabeth Warren wrote in a Wall Street Journal op-ed that the Fed is at risk of triggering a “devastating recession” if it continues raising interest rates at the current pace.

But when asked for his opinion on Warren’s warning during a recent interview with Yahoo Finance, Kroszner said that, while there is an “elevated possibility” of an imminent recession, he does not see a devastating recession as being likely right now.

Not the 1980s

When explaining why he believes the chances of a severe recession are unlikely, Kroszner took to history.

The similarities between 2022’s economic environment and the 1980s are certainly there. The annual inflation rate today sits at 9.1%, the highest it has been since 1981, and the Fed is resorting to a similar strategy of aggressive interest rate hikes to bring down demand and cool the economy.

But the Fed has learned a few lessons from past mistakes this time, Kroszner says, as the central bank is unlikely to stop raising rates until it is certain inflation has subsided.

“That was one of the things that the Fed got wrong in the late 1970s,” Kroszner said. “Inflation went up, they started to raise rates. Then inflation came down a little bit, and they brought rates down. Inflation then really took off and they had to raise rates to double-digit levels.”

The latest Fed rate hike, approved last week, has brought the Federal rate to a range between 2.25% and 2.5%. In 1981, the last time inflation was this high, the Fed placed borrowing rates as high as 19%.

“They’re going to keep [interest rates] raised because they need to make sure inflation comes down and comes down consistently,” Kroszner said.

Rising risks

Fed officials have publicly stated that they are more focused on fighting inflation than avoiding a recession, something Kroszner agreed should be the agency’s “primary objective.”

But that doesn’t mean the central bank is not thinking about the chances of a recession at all, and Kroszner says that the institution should stay cautious with interest rates if it wants to engineer a “soft landing” for the economy, wherein inflation subsides without a debilitating rise in unemployment or market downturn.

The risks are there, Kroszner says, especially in the economy’s low unemployment levels and labor market, which has so far stayed remarkably strong despite rising rates, and has been the reason many economists have considered a mild recession to be the more likely outcome.

But that could change quickly due to the Fed’s hawkish stance.

Rising rates could cause the labor market to “weaken considerably,” Kroszner said. “You can’t raise rates so much and have so many negative shocks to the economy and only get the unemployment rate to slightly go above the long-term average.”

The “negative shocks” Kroszner is warning about are harder to predict, and far out of the Fed’s control.

They include the world’s ongoing supply chain issues, high energy prices, the war in Ukraine, and the effect rising geopolitical tensions in Asia have had on global markets.

The U.S. unemployment rate currently sits at 3.6%, and earlier this year the Federal Reserve forecasted that it wouldn’t go above 4% for the foreseeable future. But this target may become increasingly hard to achieve considering the rising macroeconomic risks. 

Kroszner says that he expects the unemployment rate to go higher than 4%, which will be a strong indicator of how bad a recession will be. An unemployment rate of 5%, while still a significant increase, would be “pretty good by historical standards,” he said, and would likely constitute a soft landing for the economy.

But the negative shocks set to hit the U.S. from around the world leave the economy in a “fragile state,” Kroszner said, and could send the unemployment rate to 6% or higher.

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Source: Fortune.com

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