Opinion: The US can still avoid a recession. Here’s how

Opinion by Joseph H. Davis for CNN Business Perspectives

The United States economy is in jeopardy. Higher prices for essentials like food and energy are crimping household incomes, while stronger consumer demand has pushed up the prices for a range of goods and services, from travel to apartments.

Given this backdrop, many economists believe that recession is inevitable either this year or next. To be sure, our own economic forecasts show the path to a continued expansion has narrowed quite considerably, with the odds of recession at more than 50% over the next 18 months.

But there are ways the US economy can still avoid a recession. Here’s what needs to happen in the coming months in order to avert a downturn.

Lower consumer inflation expectations

Today’s creep-up in inflation expectations pales in comparison to the rapid rise seen in the 1970s, yet they are still high. Research by the Cleveland Fed shows that most individuals do not expect their future income gains to offset the expected rise in future inflation, meaning they expect inflation to reduce their purchasing power. This does not bode well for future consumer spending.

The Federal Reserve should continue their aggressive hikes of the federal funds target rate to at least 3% by the early fall. Vanguard’s view has been that 3% is the minimum rate needed to cement the public’s belief that price increases will ease soon. Given the lags in monetary policy, getting there quickly would reduce longer-term tail risks by throwing more cold water on rising inflation expectations.

Oil prices below $100 a barrel

According to the Bureau of Labor Statistics, the consumer prices for gasoline and other fuels have increased 34.6% over the past 12 months, helping to push inflation to 8.6% today. My calculations reveal that consumers have spent an additional $280 billion on just food and energy alone over the past 12 months, a major contributor to the decline in personal savings rates.

If oil prices dropped below $100 a barrel and stayed there, that drop in fuel costs would help offset the entire increase in food costs. Lower energy prices would also reduce the CPI inflation rate by 2.5 percentage points by year end, according to my calculations.

Bigger retail inventories

Since the start of the pandemic, economies have been buffeted by one supply shock after another. Outside of food and energy, shortages of consumer products ranging from cars to home furnishings have helped lead to price increases. Retailer inventories are starting to build up again as consumers pull back on certain spending and supply chains straighten out. But they are not yet at levels that would be enough to lower prices, which is key to bringing the Consumer Price Index down.

This summer, we need to see an additional $100 billion in retail inventories for consumer products, which would bring inventory and sales ratios back to more normal levels at US retailers, according to my calculations. More stocked shelves would also help shave 1.5 percentage points off inflation in the coming months.

Americans returning to the labor market

The lack of workers is presently a bigger supply headwind to US economic growth than the supply chain disruptions. With nearly two job openings for every one unemployed American, this condition may be the toughest to meet this summer. But it is possible.

Over the past 12 months, the US labor force has added nearly three million people. More are likely to enter if Covid cases remain low or they feel the pressure of higher prices. Indeed, the number of people who are not searching for work due to concerns over getting Covid has dropped by one million since the start of the year, according to the U.S. Census Bureau.

Another million Americans returning to the labor force through the early fall would help fill some of the job openings and thereby cool wage growth to a still-healthy 4% pace, according to my calculations. Wage growth at that rate would reduce the need for the Federal Reserve to raise rates to 4% or higher, which could forcefully destroy labor demand.

All four of these conditions will need to be met in the months ahead in order for the US economy to avoid a recession. Taken together, they would bring headline inflation down below 4% by the end of 2022. That would stabilize financial markets and improve consumer confidence later this summer, indicators that the economy has avoided a recession.

Soft landings are rarer than recessions and are far more difficult to navigate. But even though the US economic expansion’s path is narrowing, the road ahead isn’t blocked just yet.

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