Money the Federal Reserve pumps into the economy should be limited to what is necessary for financial system stability, and not expanded to avoid a recession or minimize the impact of one that may already be underway.
That is the opinion of Marek Kolar, an associate professor in Trine University’s Ketner School of Business, who believes the next recession will last longer and bring higher unemployment rates than the Great Recession. He holds a Ph.D. in macroeconomics from Michigan State University.
With the trade war and amount of debt burdening the economy — particularly the rapidly expanding federal deficit — it “seems like the overall situation may be worse than 2008,” he said.
“Before, rates were higher than they are now, so when the Fed tried to stimulate the economy, it was easier,” Kolar said.
But, with lower rates at the outset of its efforts to keep the nation at full employment, “it may be more difficult to stimulate the economy,” he said. “And, with the inflation, they may not be willing to do that as much.”
The Fed reversed its course of normalizing the interest rate and lowered its federal funds rate target during its open market committee meetings in July and September, he said.
In July the target was lowered a quarter of a percent to a range of 2% to 2.25%, and in September it was lowered the same amount to a range of 1.75% to 2%.
After its September meeting, the Federal Open Market Committee reported the labor market was strong and economic activity was rising at a moderate rate, with household spending rising at a strong pace. But, it also noted business fixed investment and exports had weakened.
With a statutory mandate to foster price stability as well as maximum employment, it said the overall inflation rate and inflation for items other than energy and food remained below its 2% target on a 12-month basis.
Labor Department data showing the core Consumer Price Index rising 2.4% during the 12 months ended in August challenges the Fed’s views on inflation, Kolar said, as does money supply growth, which “has picked up from close to 3% a year ago to over 5% as of September 9.”
If a recession is underway or gets underway with inflation above 2%, “the Fed may find itself unable to effectively address the situation, and we may see a recession that is worse than the recession in 2008,” he said in a statement.
The Great Recession started in December 2007 and ended in June 2009, according to the National Bureau of Economic Research. Fort Wayne unemployment peaked at 12.5 percent in February 2010.
The economy traditionally has moved through cycles of expansion and contraction, and this summer the nation saw a record set for the longest expansion in U.S. history. Kolar and many other economists expect the expansion to end.
“As a recession seems to be unavoidable, in my opinion the Fed should focus on its stable prices mandate and keep the inflation rate from rising above its 2% target, even if it means letting the economy go through a period of a severe recession,” he said.
In addition to normalizing the interest rate, the Fed until recently had been reducing the size of its balance sheet, which had ballooned five-fold to more than $4 trillion to support economic recovery through a program called quantitative easing, which involved its purchase of Treasuries and mortgage-backed securities.
“Within the last couple of weeks, they’ve again started increasing the size of the balance sheet. There was something happening in the repo market, the interest rate there shot up a lot, and the feds stepped in,” Kolar said. “It seems like there are signs of monetary policy easing again.”
To avoid an increasingly likely stagflation scenario, where costs rise without economic growth, “at some point there has to be a choice between letting the government borrow ever more money or a choice to take money out and let the recession occur,” he said. “I think the longer they wait, the worse it’s going to get.
By reducing the use of household and corporate debt and the excess of imports over exports, a recession would cure some of the imbalances underlying inflation, Kolar said.
With the imbalances reduced, “the economy may be able to start growing again consistently at rates close to 3% or above,” he said.
The recession may already be underway because gross domestic product numbers typically are revised after they are released, he said.
Many consumers base their opinions about the economy on what is happening with the labor market, and August employment data released by Indiana Workforce Development Sept. 23 showed all 92 of the state’s counties at full employment.
Within northeast Indiana, Wabash County had the highest unemployment rate, at 3.1%, and Wells County had the lowest, at 2.5%. Allen County’s was 3%. All of the region’s counties were below the state unemployment rate of 3.2%.
But, “tracking unemployment is telling us what has happened, not what is going to happen,” said Rachel Blakeman, director of the Community Research institute at Purdue University Fort Wayne.
“Here’s what we know: There is going to be a recession. Here’s what we don’t know: when will that happen,” she said.
Responding well as a region to an eventual downturn will be important, because “we have an economy here in northeast Indiana that is particularly prone to benefit when we have expansion and hurt when we have contraction,” she said.
Because northeast Indiana is among the most manufacturing-intensive regions of the country and Blakeman said manufacturing orders are a leading indicator of economic strength or weakness, its residents may be among the first to notice the recession’s impact when it eventually arrives.
On Sept. 30, the Institute for Supply Management’s Purchasing Managers Index, based on a survey of manufacturing supply executives, showed a second successive month of industry contraction.
Manufacturing is expanding when the index is above 50 but contracting when it is below 50, and August was the first month of contraction in three years.
The index fell to 49.1 in August, then to 47.8 in September. A year ago, it was 59.8. In August 2016 it was 49.4.