- Several policy responses to the Great Recession have made the US economy vulnerable to a different kind of downturn that could arrive within 18 months, according to to the Economic Policy Institute.
- The Washington, D.C.-based think tank recently detailed what could cause the next recession, and why it won’t be easily solved by traditional tools.
- Visit Business Insider’s homepage for more stories.
Wall Street was central to the genesis of the last two recessions, as it facilitated the bubbles that brewed in housing and software stocks.
But the next recession is unlikely to be triggered by overpriced assets, according to the Economic Policy Institute, a Washington, D.C.-based think tank that recently published a report examining the next major downturn.
Josh Bivens — the EPI’s director of research, who also authored of the report — focused instead on other causes that have been in the making during the nearly 10 years of economic recovery.
For starters, he said there’s a "real possibility" that the US slips into recession within the next 18 months, thanks to excessive interest-rate increases and the fading impact of tax cuts. He echoed prominent economists like Paul Krugman and several Wall Street experts who see a heightened risk of a downturn by the end of 2020. Krugman, like Bivens, is concerned that we’re not adequately prepared to handle the next shock.
"The US is poorly prepared for the next recession — but not for the reasons most people think (allegedly too-high public debt and too-low interest rates)," Bivens said in the report.
Instead, he said we’re poorly prepared for reasons including policymakers’ failure to rein in the power of the financial sector and to fight inequality.
Although Bivens counted out asset bubbles as the primary cause of the next recession, he doesn’t let Wall Street off the hook completely. In fact, the way regulators treated Wall Street amid the 2008 recession is one contributing factor to why, in his view, we’re ill-prepared to combat the next recession.
The Federal Reserve rushed to the financial sector’s aid to prevent it from collapsing during the last crisis. By 2009, measures of market stress, such as the spreads between Treasury yields and other interest rates, were back to normal. Stocks also started rallying.
The return to a sense of normal probably weakened the sense of urgency among regulators to ensure a recovery for all, not just Wall Street, Bivens said. And the repercussions will have to be confronted as the next crisis nears.
His other reason struck at the heart of what Bivens described as the underlying cause of most recessions: a slump in aggregate demand. Put simply, recessions happen as people curtail their spending en masse and the businesses they patronize respond by implementing cost-cutting measures including layoffs.
Inequality has worsened this dynamic, Bivens said. Low- and middle-income households tend to spend a higher share of their compensation than richer households. However, their wage growth has been sluggish for most of this expansion, thereby placing a cap on how much aggregate demand they have been able to generate.
As it stands, any sudden dent to their incomes would be damaging not just to the individuals but to the economy.
It’s not only households that have faced a ceiling on their ability to spend, according to Bivens. For most of the recovery, the US government was skittish about fiscal stimulus because of concerns about the level of debt.
Ironically, this is exactly the tool needed to fight the next recession — not primarily Fed policy, in Bivens’ view.
"A key lesson from the Great Recession is that fiscal policy is the most effective tool for aiding recovery," he said. "Monetary policy can lay the groundwork for fiscal policy, but really cannot be relied on to play more than a supporting role for fighting recessions."
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