Is a US recession inevitable? What does the history of consumer sentiment tell us?

• Six million people expected to be newly unemployed in the last two weeks.
• Consumer sentiment parallels in the Reagan recessions of 1980 and 1981.
• The US economy will rebound once curbs are removed and confidence restored.

 

The traditional definition of a recession is the well-known two successive quarters of negative growth. 

Even in normal times there are formidable difficulties in projecting economic conditions six months in advance. Yet despite the thoroughly abnormal economic situation with a vast number of unknowns, the operating assumption for many analysts and the media seems to be that a recession is inevitable. 

Using the standard two quarter metric is the United States headed for the first official slowdown since the financial crisis over a decade ago? 

Statistics that capture the state of the US economy after the onset of the coronavirus are scarce so this discussion will be based on speculative logic. Let us look at the initial jobless claims numbers and infer what we may about consumption and the overall economy.

Then we will examine the interplay between the Federal Reserve policy under Paul Volcker in the first Reagan term and consumer sentiment.

Initial jobless claims

Last week a record 3.283 million people applied for unemployment benefits. The forecast for this Thursday is that another 3 million will enroll.  This is not simply a record but more than four-and-a- half times more people than have even filed in any week before. The previous high was 695,000 in the first week of October 1982.   Even correcting for the 41% increase in population since that year would bring the claims number to barely one-third (980,000) of last week’s total.

Not only are the numbers astronomical but the extremely rapid onset truly warrants the adjective unprecedented. Two weeks before initial claims were 211,000, near the half century low where they had been for more than a year.  In 1982 the October peak came at the end of an almost two year rise in joblessness.  In 2009 the lead into the 665,000 top in March was about 18 months

Unemployment and consumption

Unemployment insurance is designed to partially replace income. It helps to maintain household necessities but of the people who have lost or will lose their jobs, most will cut spending to essentials.  But that is not the only effect of the historic job losses and the pandemic. 

Fear of layoffs is widespread. Among the vast majority who have retained their jobs the impact of the crisis will cause a general reduction in spending. Many will choose to conserve their resources for an uncertain future.

Closures of non-essential businesses, locally defined, in large swaths of the most populous parts of the country will further drain economic activity.

Consumption in the entire consumer sector, especially discretionary spending, will pull back.  In an economy where 70% of activity derives from consumers’ choices any drop in spending translates directly to GDP.

Retail sales for March on April 15 will give some sense of what may be coming as will durable goods on April 24 which include purchases of big-ticket items many of which are optional.

The real dimensions of the strike at consumption will not become known until the April figures are released in May.  A decline in GDP of 5% or even 10% in the second quarter as some economists have projected is possible but the modeling that produces these figures necessarily includes untested assumptions about consumer behavior.  The fact is we do not know what Americans will do.

Consumer confidence

One place to look for intentions is in the history of consumer confidence numbers and their reaction to previous recessions and collapses.  

There are two examples from the past generation worth examining, the 1980-81 double dip recession in Reagan’s first term and the 2008 financial crash.  

The earlier recessions have an interesting parallels to the current situation. Both were caused by government action. I am not arguing the necessity or appropriateness of the government’s role in each crisis just the irrefutable fact that its intervention was largely responsible for the economic downturns.

Reagan's double dip recessions

In 1980 it was Fed Chairman Paul Volcker's campaign to end inflation that had reached 15% in early 1980 by using interest rates and recession to break the expectations that had become built into the economy after 20 years of ever higher prices.  

His policy worked but only after the deepest recession and highest unemployment since the Depression.  Rates peaked in May 1981 at 19% and then came off rapidly. Seven months later in January 1982 the fed funds were 12% and by that December 8.5%.

Michigan consumer sentiment had reached its all-time low of 51.7 in May 1980 and rebounded to 77.2 in August 1981. It then plunged again to 62 in March 1982 in the second recession.  

From May 1981 when the fed funds was at 19% to March 1982 when the Michigan sentiment was at its second bottom the base rate had already dropped to 14%. It would continue lower to 9.5% in October 1982 when sentiment had returned to 73.4 and 8.75% in May 1983 when sentiment had reached 93.3.  Sentiment continued higher to 101 in March 1984.

Fed funds and consumer sentiment

Reuters

There was little dispute at the time of Volcker's policies who was responsible, the Reagan administration, though the policy had begun under Carter, or that a recession would be the initial result.   It was not unreasonable of consumers to view the government as the perpetrator of the recession which ultimately achieved its goal of reducing and eliminating inflation as an economic concern.  The policy, painful as it was benefited all.

Nor was it unreasonable for consumer sentiment to rebound strongly as it became clear that the high interest rates were being withdrawn.

Trough to peak in Michigan consumer sentiment was twenty four month from 62 in March 1982 to 101 in March 1984. In the fed funds the high of 19% was followed 20 months later by 8.5%.

The decline in the fed funds from 14% to 8.5% coincides with the rise in consumer sentiment from 73.4 to 93.3.  With about a nine month initial delay as rates came off, consumer sentiment had soared.  The trough to peak in consumer sentiment of two years, 62 in March 1982, 101 in March 1984 was the fastest increase in consumer sentiment in the history of the series.

In contrast the 2008 financial crisis and recession had no clear agent. Government responded to a crisis that had many causes, some of which were its own policy, but there was no one action akin to Volcker's interest rate bomb that had blown up the economy.  Consequently consumer sentiment had no one place to look for amelioration and its recovery was far slower.

The recovery from the initial plunge to 55.3 in November 2008 to the first top of 77.5 in February 2011 took 27 months. From the second bottom in sentiment of 55.8 in August 2011 to the pre-recession high of 98.1 took until January 2015, 40 months.

From the first low in sentiment in May 1980 at 51.7 to its peak at 101 in March 1984 took 47 months. The equivalent trip after the financial crisis and recession took half again as long, 75 months.

How is the pandemic like the fed funds?

The current economic slowdown is artificial, it has an end date. Try a thought experiment. Imagine that next week an effective treatment were found for the Coronavirus, what would be the result?   The resumption of normal economic processes and skyrocketing markets would be almost immediate, even if it might take months to deploy the cure to all who needed it.

The government ordered business closures and isolation are in response to a specific threat. We do not know how successful they will be, though there are some encouraging signs. History tells us that pandemics end and so will the restrictions that have, we assume, cratered the economy.

While we do not know the timeframe, the situation is analogous to the Fed’s inflation campaign under Carter and Reagan. There is an agent, the federal government, or if you prefer, the pandemic. As the economy and consumer sentiment rebounded sharply in 1982 once it became evident the cure was successful, so will consumer sentiment, spending and the economy rebound, when the pandemic begins to ebb.  Were that to happen before the end of the second quarter there will be no recession in the following three months.