Are We Due for a Recession?

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The stock market ended 2018 down seven percent for the year, pushing the market into bear market territory. Does this mean a recession is around the corner in 2019?

Recessions, on average, have occurred (roughly) every eight years since the end of World War II. The current economic expansion, which has been going on since June 2009, is longer than average. This leads people to think that the U.S. is due for a recession.

However, just because an expansion is longer than average does not mean a recession is around the corner. The economy tends to remain on its current trajectory unless it is hit by an external shock. These shocks can be good, which leads to an economic boom. An example is when record-low oil prices and the advent of the internet age caused the U.S. economy to boom in the mid-to-late 1990s, which produced record-low unemployment and the first balanced federal budget in a generation.

“Bad” shocks, which lead to recessions, are more common. Examples include the oil shocks of 1973-75, 1980 and 1991, which produced three recessions. The 1973-75 oil shock was caused by the Middle Eastern oil embargo to the U.S. The reduction in oil supply caused oil prices to triple, resulting in a severe recession. The Iranian Revolution in 1980 and Saddam Hussein’s withdrawal from Kuwait in 1991 also disrupted oil supply, increasing oil prices and causing a recession. Had these geopolitical events not occurred, these recessions would have been avoided.

The recession from 1981-82 was caused by the Federal Reserve substantially increasing interest rates to eliminate the inflation that had been wreaking havoc on the economy during the 1970s. The “Great Inflation” of the 1970s was caused by irresponsible fiscal and monetary policy during that time period and required a recession to eliminate it. The Great Recession of 2008-09 was arguably caused by loose monetary policy and a government housing policy that both served to inflate a housing bubble. Had these policy mistakes not been made, these recessions could have been avoided. This would leave just one recession over the last 45 years, the mild recession of 2001.

There is no guarantee that recessions must arrive at regular intervals. Australia has not had a recession in 27 years! There is no guarantee that a bear market will usher in a recession. The U.S. economy has endured bear markets before without a recession following. As the late Nobel Prize-winning economist, Paul Samuelson, once quipped, “the stock market has predicted 9 out of the last 5 recessions.”

Oil prices are unlikely to cause the next recession. The U.S. is much more energy efficient now than it was in the 1970s. The U.S. is also now a net energy exporter, making the effect of oil prices on the economy ambiguous. The United States seems to be avoiding previous policy mistakes, such as inflation and the housing bubble, which caused the non-oil price related recessions. I remain cautiously optimistic about the economy going into 2019.

 

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