Philly’s top economist thinks the U.S. can avoid a recession

Economists’ attention is often focused on month-to-month ups and downs in the economy. In so doing, it is easy to lose sight of the more-fundamental forces that may bear on what’s happening. This is likely one of those times.

Calls for a recession in coming months are endemic. Yes, recession risks are uncomfortably high, given runaway inflation and the Federal Reserve’s effort to rein it in through aggressive interest rate hikes. But the economy’s fundamentals are sound, and there are good reasons to be optimistic that the economy can avoid a downturn. Let’s consider them.

First are the healthy finances of the typical American household. Despite everything from the pandemic to the Russian invasion of Ukraine, there are plenty of jobs, unemployment remains low, and layoffs are about as low as they’ve ever been. Tech, housing-related and financial services companies are cutting payrolls, but those losing their jobs are quickly finding new ones.

Many households saved a lot more than usual during the pandemic; stuck-at-home families weren’t able to spend the way they normally would. Middle-income and especially high-income households are flush, and while they are now drawing down their checking accounts, they still have plenty of cash to supplement their purchasing power.

Most households have also done a good job managing their debts. The share of their incomes going toward principal and interest payments is near a record low, and for the most part these payments won’t increase with the higher interest rates. Through the various mortgage refinancing waves of recent years, households paid off higher-cost and variable-rate credit card debt with long-term, fixed-rate mortgages.

Households are less wealthy, given the decline in stock and crypto prices this year, and house prices seem set to fall further. But these price declines notwithstanding, households are still much wealthier than they were even before the pandemic.

In our consumer-oriented economy, shoppers are the firewall between an economy in recession and an economy that skirts a downturn. While the firewall is sure to come under pressure, particularly as financially hard-pressed low-income households struggle, it should continue to hold.

American businesses are also in good financial shape. They are making lots of money, with close to record profit margins. They’ve been careful, for the most part, not to take on too much debt, and they were good at locking in record low interest rates when they were available. Businesses are also investing strongly in labor-saving technologies and improving the resilience of their supply chains, as they admirably adjust to the disruptions caused by the pandemic.

Some businesses are sure to run into trouble as the economy slows. They’ll be forced to cut jobs and investment, but most of these will be companies levered up by private equity firms looking to juice-up their returns. However, there aren’t enough of these companies for their cuts to become an economy-wide problem.

The nation’s banking system is also on about as strong financial ground as it has ever been. Following the financial crisis more than a decade ago, regulators have required banks to hold substantial amounts of capital – the financial cushion to absorb any losses on their loans and other investment. They must also engage in stress tests to determine how they would perform in the most difficult conditions, such as a pandemic, and make appropriate changes.

It’s working. There is neither too much credit, like before the financial crisis when lenders gave loans to households and businesses that couldn’t pay them back, nor too little credit, like after the crisis when even creditworthy borrowers couldn’t get loans. Credit growth is just right.

Prior to recessions, overly optimistic developers typically build way too many homes. Vacancy rates are high and rising. And homebuilding collapses when conditions turn unfavorable, exacerbating the economic downturn.

Not so this time. Homebuilding has consistently lagged housing demand since the financial crisis, resulting in record low vacancy rates and a severe shortage, especially of affordable housing. While housing is under pressure from the recent surge in mortgage rates and decline in affordability, the shortage of housing will put a proverbial floor under the market.

State and local governments are also in stellar financial shape, with overflowing rainy day funds. Tax revenues have been strong until now, and the American Rescue Plan, the massive federal fiscal support package passed early in the Biden administration, set aside hundreds of billions for local jurisdictions.

In most recessions, state and local governments are in precarious financial straits and given their balanced budget requirements have no choice but to make cuts in jobs and programs, further hurting the economy. That’s not going to happen now.

I’ve been writing a lot in this column recently about the deep pessimism over the economy’s prospects. Consensus holds a recession dead ahead. To be sure, there is plenty to be anxious about, but there is also plenty to be encouraged about. I chose to focus on the positives. After all, it’s the holiday season.