Rising Fears of Recession

If history is a guide, the odds that the American economy is falling into a double-dip recession have risen sharply in recent weeks and may even have reached 50 percent.

Erik S. Lesser/European Pressphoto Agency

Foreclosures have remained a problem this year, as in Lawrenceville, Ga.

Economies have a strong self-reinforcing nature. When people are optimistic, they spend, which begets hiring and then more spending. When people are anxious, they pull back, which leads to a cycle of hiring freezes and further anxiety that often lasts for months.

The United States appears to have entered some version of the vicious cycle. Most ominously, job growth has slowed to a pace that typically signals the start of a recession.

Over the last 50 years, every time that job growth has been as meager as it has been over the last four months, the economy has been headed toward recession, in a recession or in the immediate aftermath of one. From early 2010 through this spring, by contrast, employment was growing fast enough to make the economy look as if it were in a recovery, albeit a modest one.

“The chances that we are in something that is going to feel like a recession are close to 100 percent,” said Joshua Shapiro of MFR Inc. in New York, who has diagnosed the economy more accurately than many other forecasters lately. “Whether we reach the technical definition” — which is determined by a committee of academic economists and based on gross domestic product, employment and other factors — “I think is probably close to 50-50.”

A double dip would present obvious political problems for President Obama, whose approval ratings have already fallen below 50 percent and who is scheduled to give a speech to Congress on Thursday outlining a new jobs plan. A weak economy also could threaten incumbents of both parties in Congress, whose approval rating has hovered around 15 percent in recent polls.

More immediately, the main significance of the recent slowdown is that the economy may not merely be going through a weak phase that will soon pass, as many policy makers hope. Instead, history seems to suggest that the situation will probably get worse before it gets better.

In a recent research paper, Jeremy J. Nalewaik, a Federal Reserve economist, described this concept as “stall speed”: once the economy slows markedly, it often continues to do so. (He did not make a forecast.) In the other two severe downturns of the last 80 years — in the 1930s and the early 1980s — the economy suffered just such a stall and fell into a second recession not long after the first.

Today, Europe’s troubles continue to weigh on banks and financial markets. Consumers remain indebted, and the housing market remains depressed. State and local governments continue to cut jobs, aggravating the problems in the private sector. Congress is unlikely to pass a major jobs bill.

The economy could, of course, defy history and turn around soon. Eventually, consumers will begin spending more on houses, cars, appliances and services, and employers will begin hiring in large numbers. A further decline in gas prices, which have generally been falling, would particularly help households.

But the latest indicators suggest that even if the economy does not continue to worsen, it appears to be too weak to add enough jobs each month — roughly 125,000 — even to keep pace with population growth. Anything less, and the share of the population that is employed will continue to fall.

Over the last four months, job creation has slowed to an average of just 40,000 jobs, or 0.1 percent, according to the Labor Department’s survey of employers. The last time such a meager increase did not coincide with a recession came in the 1950s.

The department’s survey of households presents a somewhat sunnier picture, but it is a smaller and noisier survey. And even it shows an unemployment rate of 9.1 percent last month, up from 8.8 percent in March. In the past, an increase of three-tenths of a percentage point has typically coincided with a recession.

James D. Hamilton, an economist at the University of California, San Diego, who has studied forecasting, said he believed the most likely case was still that the economy would avoid a double-dip recession. He also noted that the recent job growth numbers were estimates still subject to revision, although the unemployment rate is not.

“It’s extremely hard to predict recessions,” Mr. Hamilton said. The more important point, he added, was that the economy remained very weak, and weaker than people had expected.

Perhaps the best sign of how difficult it is to know the economy’s direction is that, as a group, the nation’s professional forecasters have failed to predict all the recessions since the 1970s, according to data kept by the Philadelphia Fed. In the last 30 years, the average probability they put on the economy lapsing into recession has never risen above 50 percent — until the economy was already in a recession.

The forecasters, on Wall Street and elsewhere, are not blind to economic change; they just tend to underestimate its severity. When the economy is on the verge of recession, the average recession odds from forecasters tend to rise to about 30 percent. There has been only one occasion, in 1988, when the chances rose above 30 percent and a recession did not follow.

And what do many forecasters say are the prospects of a double-dip recession now? Somewhere between 25 and 40 percent.

Reprinted from The New York Times, Business, of Thursday, September 8, 2011.