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Has the US economy moved from its strong recovery from the covid shock to a recession? The nature and timing of this shift has great implications for the global economy, especially for highly indebted emerging markets.

Where is the US economy now? The evidence is that the US economy is not in recession. However, it faces a difficult test in the coming year as policies are put in place, most notably by the Federal Reserve, to address the sharp, multi-decade increase in nominal wages and prices. Certainly, the US economy is slowing. It shrank in the last three months by an annualized rate of 0.9%, the second consecutive quarter of contraction. In the first quarter of 2022, gross domestic product decreased at an annual rate of 1.6%.

Two successive quarters of negative growth is often considered a recession, but it is not an official definition. Rather, the non-partisan National Bureau of Economic Research (NBER) makes this judgement on a broader view of the economy: looking at six monthly indicators to gauge whether the evidence points to a “significant decline in economic activity that is spread across the economy and that lasts more than a few months."

How do these key indicators look?

Real personal income less transfers: Real personal income has barely risen in the first half of 2022, reflecting high inflation. Equally, real disposable personal income has been declining for more than a year now.

Non-farm payrolls: In contrast, the labour market remains exceptionally tight, with low unemployment and elevated job vacancies (there are currently two for each unemployed person, an indicator of a large labour supply-demand imbalance). Payroll growth added 528,000 jobs in July, bringing the US unemployment rate to a 50-year low of 3.5%.

Real personal consumption expenditure: Adjusted for inflation, personal consumption, a key driver of growth, has continued to expand this year, rising in five of the past six months. However, it is sharply slowing from the covid recovery, growing at an annualized rate of just 1% in the second quarter.

Real manufacturing and trade sales: These have been declining this year. Manufacturing has struggled amid supply chain difficulties, slowing consumer spending and a shift of spending patterns away from goods.

Household employment: Household survey indicators point to household employment levelling off since March, although it is not declining as one would expect in a recession.

Index of industrial production: Industrial production was positive in the first few months of 2022 and has flattened out more recently, showing a slight decline in June.

All in all, it does not look like we are seeing the “broad-based weakness" that we would normally associate with a recession. However, US growth is slowing as the Fed signals an assertive tightening of monetary policy and financial conditions tighten. In its latest update, the IMF slashed its US growth forecast to 2.3% this year, a drastic 1.4 percentage points lower than the April forecast, with growth projected at just 1% for next year.

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Looking ahead: Absent negative shocks, an important question for the world economy is whether the US can bring inflation back to 2% without precipitating a recession. This issue is closely related to the economy’s productive capacity, which needs to be rebuilt. While the outlook is uncertain, it would be no surprise to see unemployment rising from the current to 5-6% by 2024 alongside a further slowdown in activity, with GDP contracting in one or two quarters. Such a path for the economy could qualify as a mild recession (in 2001, unemployment went from 3.9% to 5.7% and was later called a recession). As such, the focus should be on a prospective recession next year (or heading into 2024), and less about whether negative growth in the first half of 2022 means the US is in recession today.

In this context, the US economy needs lasting changes to rebuild its productive capacity potential—by releasing supply-side constraints, supporting labour force participation, incentivizing investment and innovation, developing a road map for climate policy, and raising productivity. Among these, the Infrastructure Investment and Jobs Act passed last November was one step toward addressing supply-side constraints to growth. However, other steps in the agenda then failed to secure Congressional support. Also, the US has failed to return to open trade policies by reversing tariffs put in place by the previous administration. Against this period of relative inaction, the US Congress has just recently revived critical parts of the stalled reform agenda:

•The new CHIPS-Plus Act focuses on significantly boosting domestic semiconductor production and authorizing scientific research for the next 10 years. However, the pursuit of supply chain resilience should not favour domestic over foreign producers or fragment the global trading system.

•The Inflation Reduction Act, nearing approval, would push into motion strategic investments to promote clean energy and tackle the worsening climate crisis, while trying to address healthcare spending.

The near-term implications for the fiscal deficit and debt from this additional spending would be offset by accompanying revenue measures, so should have a minimal net effect on both near-term growth and inflation (but will help US transition to a cleaner economy).

Overall, the US economy is not yet in recession and more needs to be done by the Fed to re-anchor inflation expectations. Thus, emerging markets and their central banks should expect its tightening to continue.

Anoop Singh is a distinguished fellow at the Centre for Social and Economic Progress, and a former member of the 15th Finance Commission.

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