Intimations of Recession

Paul Krugman

These are the dog days of summer, but there's a chill in the air. Suddenly —
really just in the last few weeks — people have starting talking seriously
about a possible recession. And it's not just economists who seem worried.
Goldman Sachs recently reported that the confidence of chief executives at
major corporations has plunged; a clear majority of C.E.O.'s now say that
conditions in the world economy, and the U.S. economy in particular, are
worsening rather than improving.

On the face of it, this loss of faith seems strange. Recent growth and jobs
numbers have been disappointing, but not disastrous.
But economic numbers don't speak for themselves. They always have to be
interpreted as part of a story. And the latest numbers, while not that bad
taken out of context, seem inconsistent with the stories optimists were
telling about the U.S. economy.

The key point is that the forces that caused a recession five years ago
never went away. Business spending hasn't really recovered from the slump it
went into after the technology bubble burst: nonresidential investment as a
share of G.D.P., though up a bit from its low point, is still far below its
levels in the late 1990's. Also, the trade deficit has doubled since 2000,
diverting a lot of demand away from goods produced in the United States.
Nonetheless, the economy grew fairly fast over the last three years, mainly
thanks to a gigantic housing boom. This boom led directly to unprecedented
spending on home construction. It also allowed consumers to convert rising
home values into cash through mortgage refinancing, so that consumer
spending could run far ahead of families' incomes. (Americans have been
spending more than they earn for the past year and a half.)

Even optimists generally concede that the housing boom must eventually end,
and that consumers will eventually have to start saving again. But the
conventional wisdom was that housing would have a "soft landing" — that the
boom would taper off gradually, and that other sources of growth would take
its place. You might say that the theory was that business investment and
exports would stand up as housing stood down.

The latest numbers suggest, however, that this theory isn't working much
better on the economic front than it is in Baghdad.

Signs of a deflating housing bubble began appearing a year ago, but for a
while it was possible to argue that eliminating a bit of "froth" in the
housing market wouldn't do the overall economy much harm. Now, for the first
time, problems in the housing market are starting to seriously reduce
economic growth: the latest G.D.P. data show real residential investment
falling at an accelerating pace. The latest job numbers show falling
employment in home construction, and retail employment has fallen over the
past year, suggesting that consumer spending is running out of steam. (Gas
at $3 a gallon doesn't help, either.)

Meanwhile, neither business investment nor exports seem to be growing fast
enough to make up for the housing slump.

Now maybe we'll still manage that soft landing despite a rapidly rising
number of unsold houses; or maybe there's a boom in business investment
and/or exports just over the horizon. But based on what we know now, there's
an economic slowdown coming.

This slowdown might not be sharp enough to be formally declared a recession.
But weak growth feels like a recession to most people; remember the long
"jobless recovery" that followed the official end of the 2001 recession?

And what will policy makers do about a slump, if it happens? A snarky but
accurate description of monetary policy over the past five years is that the
Federal Reserve successfully replaced the technology bubble with a housing
bubble. But where will the Fed find another bubble?

And with the budget still deep in deficit and the costs of the Iraq war
still spiraling upward, it's hard to see Congress agreeing on any
significant fiscal stimulus package — especially because history suggests
that the Bush administration and Congressional leaders will turn any debate
about how to help the economy into yet another attempt to smuggle in tax
cuts for the wealthy.

One last thing: the real wages of most workers fell during the "Bush boom"
of the last three years. If that boom, such as it was, is already over,
workers have every right to ask, "Is that it?"