Is a major recession unavoidable?

Three economists discuss the recession. Right now, we are caught in a bind twice. Despite the fact that prices are skyrocketing, the economy appears to be shrinking.

Normally, increasing interest rates is the response to rising prices, but doing so also encourages consumers and businesses to reduce their spending. The difficulty for central banks is to attempt to address both issues at once.

Three experts were questioned about whether they could reduce inflation without severely impacting the economy. They stated the following:

University of Sheffield Senior Lecturer in Economics Jonathan Perraton

In contrast to the U.S. Federal Reserve’s 0.75 point increase the day before to a range of 1.5 percent to 1.75 percent, the Bank of England decided to raise interest rates by a very small 0.25 percentage points to 1.25 percent. This underlines UK worries that economic growth would be less robust than anticipated.

It comes in the wake of alarming predictions from the Organisation for Economic Co-operation and Development (OECD) that the UK will have the worst performance of any major economy in 2023, save from Russia, and the unexpected announcement that the UK GDP contracted by 0.3 percent in April. All key sectors are contracting, and the GDP has barely risen over its pre-COVID level in recent years.

Despite the fact that inflation is already at 9 percent and is now predicted to increase to 11 percent in the next months, the Bank of England is being cautious. Since the 1980s, these levels have not existed. According to projections, the UK will have one of the highest inflation rates among the major economies.

graph displaying the inflation rate across African nations

Due to strains on supply chains following COVID and increasing energy and other commodity prices following Russia’s invasion of Ukraine, inflation is a global issue. But according to American economist Adam Posen, Brexit is a major element in understanding why inflation in Britain is so high. Higher trading expenses, a falling pound, and a labor scarcity are the results of this.

Although employment rates are still below pre-COVID levels, the unemployment rate has decreased to just 3.8 percent, indicating that more people, especially older employees, are not working. Staffing issues have emerged as a major aspect of the British economy.

Given the low unemployment rate and the number of open positions, you may anticipate an increase in earnings. The largest decline in regular pay in more than 20 years occurred in June, when regular pay, excluding incentives, decreased by 2.2 percent in real terms. Therefore, at least for now, it does not seem like we are experiencing the typical wage-price inflationary spiral, in which businesses give in to worker demands for greater compensation, pass on the costs to consumers in the form of higher prices, and workers then demand even higher wages to make up for it. Having said that, the negotiation rounds have not yet ended.

Consumer demand has up to now played a role in boosting economic activity in the UK, but household savings have also played a role. There are clear limits to how deep households may delve into their savings when living standards are stretched, although some of this represents households spending more now that COVID restrictions have been loosened. Consumer confidence is declining, which is not surprising.

Longer-term issues are still present. Since the global financial crisis of 2008, UK productivity has been extremely low. There are numerous potential causes, including limitations in capital investment and training, the latter of which is mirrored in the current challenges with filling positions.

In conclusion, the Bank of England is dealing with unusual difficulties. Interest rate increases are a blunt instrument to address supply-side issues in a British economy where growth has stalled. People will likely need assistance from the government rather than the Bank of England as long as inflation exceeds salaries and the economy is stagnant.

Professor of International Economics and Economic Policy at Queen Mary University of London, Brigitte Granville

The question of whether we are headed for an episode as catastrophic as the 1970s or even worse must be at the forefront of any discussion of “where next?” given that stagflation is already here. My response is that while a recession is likely, the experience of high inflation persisting despite numerous warnings throughout the 1970s provides some hope.

The most gentle solution to the current predicament would be for inflation to quickly correct itself, making individuals less wealthy in real terms so they can’t afford to buy as much. In this scenario, central banks would stop raising interest rates, which would reduce inflation and help the economy recover.

However, there are a number of barriers to such a quick turnaround, including the labor market and the setting of the post-COVID recovery.

Two sources on the global supply side have contributed the majority of the inflationary impetus. First, China’s zero-COVID policy made it harder for supply chains to handle demand that collapsed and then surged during and after COVID. Second, the limited availability of oil and other natural resource due to Russia’s conflict in Ukraine

Pent-up demand from western businesses and consumers as a result of COVID stimulus programs in the UK and especially the U.S., as well as unspent money amassed during lockdowns, are prolonging the inflationary consequences of these crises. As recently as April, household bank balances in the UK, for instance, were still significantly higher than those prior to COVID.

It doesn’t help that loose monetary policy has elevated the financial markets to such levels. Although bubbles have lately burst, valuations still need to decline a bit more before consumers feel poorer and are less likely to shop.

With regard to the labor market, which is the second barrier to a quick reversal of the inflation spike, the supply side is once again the main source of concern. Post-COVID, the demand for labor from businesses has normalized, yet there are still insufficient workers. This is partially due to the fact that more people over 50 are opting not to return to the workforce, but the UK also faces the issue of Brexit, which has disrupted the flow of skilled labor from central and eastern Europe.

Companies are being obliged to pay workers more due to a lack of workers, and as a result, prices for goods and services are rising by roughly 4% annually in the UK. The Bank of England, concerned about a wage-price spiral akin to that in the 1970s,

Leading signs, however, point to a lesser threat from the wage-price spiral. The highly monitored Purchasing Managers’ Index, which measures UK businesses’ economic optimism, reveals that those in the services sector are growing more pessimistic about the next months. If you anticipate a decline in sales, you don’t keep raising prices. While there may have been traces of labor militancy similar to that of the 1970s in the transportation industry, for example, pessimistic businesses are typically more inclined to decrease employment plans and output than to concede to high pay demands, if not shut down completely.

Since this is a long-term structural issue, it seems to me that it will have a greater impact on how inflation develops than the post-COVID difficulties, which should finally get their act together. In conclusion, I anticipate that the UK economy’s current stagnation—which is quite likely to turn into a mild recession—will cause inflation to return to the 2 percent target. Sharper interest rate increases may be required to accomplish the same purpose in the US, where underlying demand and credit are stronger.

My primary concern is that central banks would become overly rigid in their pursuit of their 2 percent inflation targets. I evaluated persuasive research findings in my book “Remembering Inflation” showing inflation levels up to 5% pose little to no long-term harm to growth, especially if the inflation rate is stable.

Chris Martin, University of Bath professor of economics

The future performance of the UK economy will be heavily dependent on the labor market, whose prospects are moderately optimistic. On the one hand, it demonstrated resistance to the epidemic. The successful furlough programs shielded the labor market from the worst effects of the crisis. Despite a considerably more severe economic downturn than in the 1970s, the decline in employment was around three times lower.

Additionally, employment bounced back quicker than it had in prior recessions. Vacancies have increased by more than 50% since the outbreak. The average annual wage rise, excluding bonuses, is roughly 4%, with drivers and employees in the construction, software development, and warehousing industries seeing even higher growth.

On the other hand, employment is still near to 250,000 workers lower than it was prior to the pandemic. Real earnings have not increased since 2008. Furthermore, the macroeconomic environment is bleak: it is difficult to imagine how the labor market will flourish in the face of poor or nonexistent growth.

The upcoming months are difficult to predict due to a number of reasons. First, the unemployment rate is no longer a reliable gauge of the labor market. Today, workers are divided into three categories: employed, jobless, and inactive. While the inactive are not actively looking for job, unemployed people are. Only 20% of the approximately 250,000 fewer working people since 2019 are currently unemployed; 80% are idle.

The inactive are far less understood by economists than the jobless. This is significant because inactive rather than unemployed individuals make up the majority of the workforce.

Second, and perhaps more unexpectedly, Brexit has modified migration rather than decreased it. There are more employees from Nigeria, India, and other such nations than EU nationals in the UK. In contrast to the hospitality industry, they typically have higher skill levels and operate in the fields of health and social care.

More qualified workers should increase production and fill important positions in the health and social care sectors, but the hospitality industry is also having trouble. The future of the labor market is also made more challenging by the fact that it is unclear whether these changes will be permanent.

Additionally, it appears that there has been a change in the behavior of open positions and how they relate to hiring. According to the most recent figures, there are 1.3 million openings, which is around 40% more than before the outbreak. However, record numbers of people have not been hired as a result of this. Regardless of the reason, we can’t continue to rely on high vacancy posting to create more jobs.

Finally, a startling gap between the public and private sectors is emerging. Public sector employment lags behind the private sector, which has returned to pre-COVID levels of employment. Currently, salary growth in the private sector is 8% while it is only 1.5% in the public sector. Although there appears to be little chance of this happening, it is difficult to predict public sector employment because it is resistant to some of the market pressures that drive the private sector.

So what are the employment prospects in the UK? Most importantly, businesses are probably seeking for fewer employees as a result of persistently low investment and sluggish consumer spending, which indicate stagnant or declining GDP.

The numerous openings that businesses are currently offering, along with some of the private sector’s relatively big wage increases, will counteract these negative forces. This may encourage some of the workers who withdrew from the labor market after the pandemic to return.

In the near future, I would anticipate a decrease in employment of up to 100,000 people overall. Since that amount is less than 0.1 percent, all the other economic issues won’t be significantly exacerbated.