Lately the "R" word has been making its way into the mainstream media. Recession.
Now we have predictions of the end of the world, planets colliding and perhaps canceling the NFL season.... Well, that's a bit far-fetched, but so are the predictions of doom coming from a recession.
There is no mistaking it, recessions are not positive for the economy, but they happen at times.
They are often caused by a countermove by the Federal Reserve to cool down an overheated economy. The Fed is on guard against inflation rising sharply and out of control, so it attempts to get ahead of it. One of the Fed's two mandates is price stability. In previous recessionary periods, the conditions were such that interest rates needed to rise to fend off inflation.
But the current economy has had low interest rates for some time, and inflation is stubbornly not rising. Wages are on the rise, the job market is healthy and may be peaking, which tells us the Phillips curve -- inflation rising because of a tight labor market and increased wages -- may start to work again. The Fed would step in once more with tighter policy if this were to occur.
But the main reason we see recessions is about the consumer and the noise they hear. Day in and day out, the uninformed media makes pronouncements about scary trends and statistics. The consumer is about 70% of the overall economy, and imagine what happens when consumers hear over and over that the economy is tipping into recession. They're bound to tighten up, save more, spend and consume less. As that action spreads, the economy starts to feel the pain, and a recession becomes a self-fulfilling prophecy.
As much as the Federal Reserve tries to hold off from a contraction, there is nothing more powerful than momentum. It cuts both ways, too, and the downside can be swift and vicious. See 2008 and 2001 for recent examples.
