Is the economy heading into recession?

Commentary about business and finance.
July 31 2006 5:58 PM

The "R" Word

Are we heading into a recession?

Illustration by Mark Alan Stamaty. Click to expand.

Last week, the Commerce Department reported that the pace of economic growth had slowed dramatically, from a 5.6 percent annual rate in the first quarter to a 2.5 percent annual rate in the second quarter.

For months, members of what I call the Gloom & Doom Caucus have been warning that the inevitable slowdown in housing, rising inflation, a lack of saving, and excessive debt would send the economy off the rails. But very few have dared predict that the economy would stop growing altogether. And while no economist is prepared to declare an immediate end to the current economic expansion, which turns 5 this fall, a few pessimists have (cautiously) started using the "R" word.

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Let's meet the fearmongers, in descending order of certainty:

Gloomy forecaster No. 1
A. Gary Shilling
Likelihood of recession:
Unclear, but it could be soon. Shilling, a well-known economic consultant and adviser, last week told an interviewer that "the economy is slowing, and I suspect that by the end of the year it could very well be in recession."
The main culprit: Slowing housing market.

Gloomy forecaster No. 2
Nouriel Roubini, economics professor at New York University's Stern School of Business and proprietor of mega-macroeconomics blog Roubini Global Economics Monitor.
Likelihood of recession: 50-50, but timing is unclear. As he noted: "I do not now predict with high probability a recession but now believe that its probability has significantly increased to around 50 percent."
The main culprits: Higher oil, which will have "a stagflationary effect"; a weak housing market; and rising interest rates.

Gloomy forecaster No. 3
David Rosenberg, economist at Merrill Lynch.
Likelihood of recession: 40 percent and rising, though probably not this year.
The main culprit: The slowdown in housing.

Gloomy forecaster No, 4
Michael Mussa, former chief economist at the International Monetary Fund, currently at the Institute for International Economics.
Likelihood of recession: 25-30 percent in 2007, as Bloomberg reported.
The main culprit: Rising energy prices.

Note that all these predictions are conditional, couched, and otherwise qualified. But while they seem mild, they represent a radical divergence from the crowd. The economists surveyed by the Wall Street Journal (go here to see the forecasts) as a group foresee growth of 3 percent for the third quarter of 2006, 2.8 for the fourth quarter, and 2.7 percent for the first half of 2007. That's nowhere near a recession. And not a single member of the Journal group forecasts even a single quarter of negative growth. Other prominent forecasts are similar. The Federal Reserve Bank of Philadelphia's quarterly forecasting survey of 53 economists projects robust economic growth of 3.4 percent in 2006 and 3.0 percent in 2007.

Of course, we shouldn't expect groups of economic forecasters to see a recession coming. Sometimes it seems like the people who crunch the data and construct models are the last to know. They tend to extrapolate based on existing trends, and as a result they're not very good at calling the tops or bottoms of the economy. When two economists, James Stock of Harvard and Mark Watson of Princeton, looked at the Philadelphia Fed forecasts at the time of the last recession, they found that in late 2000, the group thought the economy would grow at a 3.3 percent rate in the first quarter of 2001. It wound up contracting at a 0.6 percent annual rate.

The problem with recession forecasting is that you never know when a recession has started until long after it begins. The National Bureau of Economic Research is the official dater of recessions, and it doesn't make forecasts. We could be in a recession now, for all we know. Lakshman Achuthan and the team at the Economic Cycle Research Institute have an excellent track record on predicting recessions (they were among the only forecasters to accurately predict the last recession). And they still believe the expansion is intact.

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