- Two of the five triggers of all US recessions over the past century pose new dangers to the US economy, according new research from Goldman Sachs economists.
- They ultimately concluded that while the odds a so-called soft landing are better than widely thought, new risks could crop up.
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Investors placed the longest economic expansion in history on death watch last summer when recession fears ran rampant.
Although their concerns have receded and the stock market has rallied forcefully into a new year, recession remains a top concern.
There’s some good news amid the gloom. Since World War II, the length of time the economy has spent in a recession has been shrinking, Goldman Sachs data shows.
The fact that we’re still experiencing a record-long expansion is proof that the economy has become more durable. Also, the Federal Reserve’s emergency support after the financial crisis persists to this day and is keeping both financial markets and economic data in good shape.
To explain this resilience even further, Goldman economists dug into the past century of recessions to unearth the most common catalysts.
Their analysis turned up five major factors which can be split up as follows: the first three have lost their potency over time and do not pose any imminent threat. However, there are brand new risks embedded in the final two.
Here they are, complete with Goldman’s assessment of the ongoing threat level:
1. Industrial shocks and inventory imbalances
The manufacturing sector’s risk to the economy has diminished since the 1980s. Thanks to improvements in technology and smarter forecasting techniques, manufacturers have become better at forestalling shocks to their output.
In addition, the manufacturing sector now contributes far less to economic growth than services, which adds about two-thirds.
2. Oil price shocks
The US first sunk into a recession on account of an oil spike in 1973.
But since then, price fluctuations have been having a diminishing impact on how the economy fares. The shale boom of the 2010s was partly responsible for this cushioning, as investment in the infrastructure used to extract and refine oil offset the hit to consumption that came about because of higher prices.
3. Aggressive rate hikes
The Fed has historically hastened recessions by hiking interest rates too quickly in the face of inflation.
“The most important structural change is the improvement in monetary policy that has flattened the Phillips curve and firmly anchored inflation expectations on the Fed’s 2% target,” said Jan Hatzius, Goldman’s chief economist, in a note.
This means the Fed can show more restraint even when inflation pressures are bubbling.
4. Financial imbalances and asset price crashes
The combo of excessive subprime lending and a housing bubble proved lethal and led to the Great Recession.
Despite the clean-up efforts of banks and regulators after the recession, financial risk remains “an important threat in principle,” according to Hatzius.
He cited two rising trends to back up this assertion. First, the share of gross domestic product that is derived from financial assets is near historic highs; in other words, the financial sector matters a lot more to the economy. Secondly, there is a higher correlation between US and other developed-market stock returns, meaning that the domestic market is more sensitive to foreign shocks.
Hatzius sees the risks stemming from these two trends as lying dormant for now — but they will be new when they arise.
5. Fiscal tightening
Herein lies the second and final source of new risks on Hatzius’ radar: optimum decisions on tax policy and government spending — which make up fiscal policy — could be jeopardized because Washington is “plagued by dysfunction.”
Hatzius added: “This dysfunction has created new economic risks arising from events such as shutdowns and debt ceiling fights that can have substantial effects on financial conditions and growth.”
The hyper partisanship exists at a time of soaring government deficits. The implication is that even if the right fiscal policy is implemented, it may prove to be less effective at averting a recession.
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