Recession on Way? Depends on Balance of Factors

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Recession on Way? Depends on Balance of Factors

On January 4, 2008 the word “subprime” was chosen as the 2007 Word of the Year by the American Dialect Society. Its definition: a risky or less than ideal loan or mortgage. In the first month of 2008, the word “recession” has come to the fore. The concern seems to be not its definition, but whether or not it will occur this year.

The popular definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters. It is straightforward measure based on a single factor – production. A broader definition is provided by the National Bureau of Economic Research. Their measure of business activity includes multiple factors, namely GDP, employment, industrial production, real income, and wholesale-retail sales. Recession is defined as that time between an economy’s peak of activity (when it stops growing) and the time it reaches its trough (when it stops declining and starts growing again). Economic activity from trough to peak is the normal state of the economy.

Recession worries increased early in the year when some large financial institutions, including Goldman Sachs, UBS and Merrill Lynch, issued recession alerts within days of each other. While some notable experts are predicting a recession, the consensus opinion continues to forecast slow growth, but not a recession.

Much will depend on the turmoil created by subprime loans and the resulting “credit crunch.” When subprime loans that are packaged with other higher-quality loans go bad, the whole package is tainted. Because it is difficult to determine the extent to which a package contains subprime loans, investors are hesitant to buy them. When these loans can’t be sold, banks have less money to lend to businesses for expansion. Another concern is the slowdown in general employment growth. Slow employment growth means slower growth in personal income. This reduces consumer spending (which accounts for more than 70 percent of total spending), and eventually affects business profits and business investment. Falling home sales and prices also reduce the number of jobs, personal income and household wealth – all of these reductions together diminish spending.

The Federal Reserve has a delicate balancing act. Aggressively lowering interest rates and increasing the money supply can lead to inflation. However, an action that is not aggressive enough will likely lead to a recession. The wrong action could result in an economy that not only doesn’t grow, but also has inflation. We experienced this “stagflation” in the early 1980s.

How is Cincinnati faring? Even though the Cincinnati region has grown more slowly for the past several years than the nation as a whole, there are signs of positive change. First, the slowdown in the housing market has not hit this region as hard as many other metropolitan areas. More important, it seems that businesses have discovered the Cincinnati region as a good place to locate. Recruiters tell me that more businesses are deciding to locate (and create new jobs) in the region than in past years. Most of these are foreign companies representing countries such as Japan, Germany, India, Switzerland and the UK. There seems to be an increasing likelihood that more jobs will be created in 2008. This is important, because, adding jobs is a powerful growth stimulant that can shield our region from a severe downturn.