The Precarious State of the American Economy
via CNN Business
Predictions of a US Recession and Unprecedented Challenges Ahead
Major economies worldwide are on the verge of, or already experiencing, a recession. While Canada and Sweden have managed to avert the downturn, Germany, the largest economy in Europe, has entered a technical recession with two consecutive quarters of negative growth.
China, once a key driver of global economic growth, has seen its post-COVID-19 recovery falter, leading the government to implement a new stimulus plan. Although the U.S. economy has so far avoided a recession, many forecasters anticipate a mild one in the coming months, as evidenced by the ongoing decline in the Conference Board's index of leading economic indicators.
Despite concerns about declining orders, labor hoarding appears to be an underappreciated but significant factor in today's economy. Companies are reluctant to lay off workers due to the challenges of finding and retaining skilled talent. However, the technology sector, which experienced over-hiring during the pandemic, has witnessed some layoffs. While the U.S. Bureau of Labor Statistics' monthly establishment survey indicates continued net job growth, the separate household survey shows slower growth. Furthermore, an increase in initial claims for unemployment insurance and a decrease in the average workweek can serve as early warning signs of an impending recession.
The stock market presents a mixed picture. While stock prices reflect expectations of future corporate profits and are highly cyclical, the recovery in U.S. equities has been concentrated in the Big Tech sector. As economist Paul Samuelson once noted, the stock market is not always a reliable leading indicator, having "predicted nine of the last five recessions."
The future course of the economy will depend largely on monetary and fiscal policies. The massive and stimulative responses to the COVID-19 recession, although imperfect, resulted in the worst inflation in four decades. After a prolonged period of near-zero interest rates, the U.S. Federal Reserve began raising rates through a series of rapid hikes. While the Fed paused in June, Chair Jerome Powell hinted at potential rate increases in July. If implemented, this would push the Fed's policy rate above both the 12-month lagging core inflation rate and the Fed's inflation expectations.
Central banks generally aim for their short-run target rates to exceed expected inflation for a significant period, allowing time for the economy to cool down and reduce price pressures and wage demands. However, the Fed's aggressive rate hikes contributed to an inverted yield curve, another typical sign of an impending recession, and the failure of several midsize U.S. banks.
If a recession does occur, it would be one of the most widely predicted in history. Yet, if it is avoided, it would be considered a significant miss by the economic forecasting community. The current situation in the United States is unprecedented, with government spending surging while the economy is already at full employment. Although there has been some agreement on suspending the debt limit and imposing modest spending constraints, significant budget battles lie ahead.
President Joe Biden seeks to implement large corporate tax increases and capital gains taxes upon accrual, rather than at the time of asset sale. Treasury Secretary Janet L. Yellen is advocating for a global minimum tax deal that would raise taxes on U.S. multinational companies. However, this proposal is unlikely to pass in the U.S. Senate, where treaty alterations require a two-thirds majority.
Republican presidential candidates oppose higher taxes and may aim to make various provisions of the 2017 tax cuts permanent. Additionally, defense spending is likely to be a contentious issue, as it currently falls short of keeping pace with inflation. These policy debates will be intensified by looming cash shortfalls in Social Security and Medicare in the coming years.
Historical evidence from the OECD suggests that successful fiscal consolidation, both in terms of strengthening the budget and avoiding recession, has primarily focused on reducing spending. Maintaining moderate marginal tax rates on savings, investment, and work is crucial for the supply side of the economy. Although higher marginal tax rates are typically associated with long-term growth effects, they significantly hindered the recovery after the Great Recession, resulting in the slowest economic rebound since World War II. Furthermore, studies have indicated that higher taxes are a major contributor to Western Europe's income shortfall compared to the U.S.
Addressing America's debt and entitlement-cost crises through higher taxes would be risky in the short term and detrimental to long-term economic prosperity. Transforming the U.S. into a European-style welfare state would limit future opportunities, particularly for those striving to climb the economic ladder. Ironically, the recent spending surge, intended to assist these individuals, may have had the opposite effect.
Overall, the U.S. economy faces significant challenges, with predictions of a potential recession, unprecedented policy battles, and diverging perspectives on taxation and spending. The outcome will shape the country's economic trajectory and have implications for future growth and opportunity.
Source: The Japan Times
