You Decide: How bad will the next recession be?

Published 7:22 am Saturday, September 21, 2019

By Dr. Mike Walden

I just finished a phone interview with a national business reporter. The topic – recession. Specifically, the reporter wanted to know how bad the next recession would be. Would it be as bad as the 2007-09 recession, a downturn so deep that economists now refer to it as the “Great Recession.”

Recently the news has been filled with stories about the odds of an upcoming recession. Yet according to one of the largest groups of economists – the National Association of Business Economists – the odds of a recession this year or next have actually dropped in their most recent August survey compared to the February survey. Where the odds have risen is for 2021, but they are still well under 50 percent.

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Yet you may have heard about economists’ forecasting abilities – economists are better at predicting the past than predicting the future! So just the fact people are talking about the possibility of a recession may be enough to cause us to worry.

So, if a recession were to occur sometime in the next three years, how bad would it be? Call me an eternal optimist if you like, but I think a good case can be made the next recession will not be anywhere near record-setting. In other words, it will be relatively mild.

Do I have any reason for saying this besides hope? Actually, I do. First is the financial condition of households. Bad recessions result when households are overwhelmed with debt. Too much debt causes households to severely cut back on spending during a recession, which boomerangs into losses for businesses, layoffs for workers and a vicious cycle of pessimism.

The good news today is household debt loads are at a three-decade low when measured by how much debt payments take out of the typical household’s disposable income. Household bankruptcies are also at a low point. The average consumer has actually become frugal during the last ten years. This may be a lasting positive impact of the Great Recession.

Manufacturing is an economic sector especially susceptible to recessions. This is because purchasing manufactured products can often be easily postponed. If households face cutbacks in work and income when a recession hits, they will likely “make ends meet” by declining to buy items like furniture, electronics, vehicles and maybe even clothing. The same is true for businesses.

Traditionally, North Carolina has had a larger manufacturing component in our economy than the nation. This is a big reason why our state usually has bigger downturns during recessions than the nation. For example, at the height of the Great Recession, North Carolina’s jobless rate was 11.4 percent compared to the nation’s 10 percent.

While manufacturing is still a bigger part of the state economy than it is in the US, manufacturing’s relative importance has declined in North Carolina in the last dozen years. In 2007, prior to the onset of the Great Recession, manufacturing in our state accounted for 22 percent of all economic activity. Today manufacturing is 18 percent of the state economy. The service sector has taken up the slack.

Please note, however, that manufacturing output has continued to increase in North Carolina. It’s just that economic activity outside of manufacturing has increased more. Yet with manufacturing a smaller part of the state’s economic pie, the bigger downturn in manufacturing during the next recession will be a little less severe for the overall economy than in the past.

Most people remember the housing market and how the plunge in home prices was a crucial factor in triggering the Great Recession. So with housing prices in many areas now at an all-time high, could history repeat itself and prompt the Great Recession II, the Sequel?

I – and many of my colleagues – think no, and here’s why. The run-up in home prices last decade was caused by a virtual frenzy in homebuying due to easy financing and unreasonable expectations. A “bubble” in home prices was created, and when the bubble burst, the economy crashed.

Today’s gains in home prices have been caused more on the supply side – in particular, a lack of supply. For a variety of reasons, builders haven’t been building like they used to. Also, homebuyers haven’t gone overboard on borrowing, and lenders have been much more constrained than in the mid-2000s.

My last positive point is state government. State governments can make recessions worse if they raise taxes or cut spending as their revenue picture deteriorates. One way to avoid this problem is if the governments save funds from previous years and build up a reserve, typically called a “Rainy Day Fund.”

The good news is that North Carolina has a substantial Rainy Day Fund. Some of the money has been used for last year’s hurricanes, but the state is on pace to replenish those funds. As a result, if and when a recession hits, North Carolina can use the fund as a backstop to avoid tax hikes and keep state spending flowing.

Hopefully a recession won’t arrive in the near future. But if it does, will it be mild, average or harsh? You decide.

Dr. Mike Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.