The U.S. economy grew at a faster pace in Q1 and Q2 than just about everyone expected. History and some recent data suggest it could keep growing.
In the post-World-War II era, the U.S. economy has endured 12 expansions and 13 recessions, according to data compiled by the National Bureau of Economic Research. In the decades after the war, the economy followed a familiar pattern – recessions and bear markets were cyclical, typically driven by the Fed raising rates too far to tame growth and inflation.1
But starting in the 1980s through the present day, economic expansions have lasted longer, and recessions and bear markets have largely been event-driven or structural – consider the 2001 tech bubble, the housing crisis and financial meltdown in 2008, and the pandemic. It’s worth noting that the Fed engaged in tightening campaigns in the mid-1980s and mid-1990s, but neither triggered a downturn. And stocks did well.
Looking at the graphic below, readers can see that before 1980, economic expansions were relatively short-lived (except for the 1960s). After 1981, expansions have gotten considerably longer, with the previous four lasting an average of 8.6 years. If a recession were to occur in the second half of 2023 – as many economists were and are projecting – then it would be less than half as long as the post-1981 average.
Source: National Bureau of Economic Research2
One of the key reasons expansions have become longer since the early 1980s is that inflation has not been much of an issue over the last few decades. In cycles prior to 1980, the Fed would work to choke-off economic expansions because of their objective to choke-off inflation, with the most relevant example of course being Fed Chairman Paul Volcker’s engineered recession in the early 1980s.
Just a few months ago, the narrative was that Jerome Powell’s Fed would need to follow in Volcker’s footsteps. But the thinking is starting to shift as inflation comes down meaningfully without much hint of strain in the broad U.S. economy. Consumer spending grew by a modest but still positive 1.6% in Q2, and business investment ticked nicely higher. The jobs market also continues to produce abundant openings and solid wages, which is the opposite of what we would see in a pending downturn. In Fed Chairman Powell’s words, “We’ve seen so far the beginnings of disinflation without any real costs in the labor market,” and “that’s a really good thing.”
The Fed’s Preferred Measure of Inflation Fell Below 4%
Source: Federal Reserve Bank of St. Louis3
While Job Openings Remain Abundant
Source: Federal Reserve Bank of St. Louis4
The case for a hard landing (i.e., recession) is that the Fed today needs to do what it used to do prior to 1980, which is to engineer a recession to bring inflation down. But it looks increasingly like the Fed does not have to do that after all, which could make the current expansion look more like the previous four.
Bottom Line for Investors
When the Fed successfully raised rates in 1984 and 1994 without triggering an economic recession, the labor market was not nearly as tight as it is today. In other words, the Fed was not worried back then about wage pressures driving inflation like they are now. This might be aptly categorized as the “x-factor” that could influence the Fed to go too far in raising rates.
I’ve argued before, however, that there are several supply-side factors that could arguably neutralize any wage-price pressures, like falling producer prices, the removal of stress from global supply chains, falling shelter costs, and the plummeting of M2 money supply which tend to lead to inflation. If these other supply-side drivers effectively offset the effect of wages that are running higher than the Fed wants, then I think it’s entirely possible that the Fed will firmly conclude a recession is not needed to get inflation back down to the target. And that could give the current expansion a lot more runway from here.
Disclosure
2 National Bureau of Economic Research. March 13, 2023. https://www.nber.org/research/data/us-business-cycle-expansions-and-contractions
3 Fred Economic Data. July 27, 2023. https://fred.stlouisfed.org/series/DPCCRV1Q225SBEA#
4 Fred Economic Data. August 1, 2023. https://fred.stlouisfed.org/series/JTSJOL#
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