Macroeconomic Lessons from Previous Recessions
Recession bets are on the table as earnings season picks up steam and the debt ceiling approaches. What can be learned from previous recessions?
- Monetary policy is blunt.
- Fiscal policy can be more strategic.
- Both take longer to impact the real-world economy than markets.
A Quick Review
In 1998, the US economy was at the end of an expansionary cycle and awash in liquidity. Consumer confidence was very high as the dot-com boom ushered in enormous wealth. Then, the Federal Reserve Board raised interest rates.
The hike scared markets and, when the bubble burst in 2000, consumer confidence plummeted. Then the Fed hiked rates again, exacerbating economic conditions. Why?
The Fed has two main tools — printing money and changing interest rates. The Fed hiked rates to cool the economy (not just markets), but may have hiked too much. Fortunately, when the Fed’s tools take the economy too far in one direction, fiscal policy can be used to get it back on course.
Unfortunately, black swan events cannot be predicted. After beginning to loosen monetary policy in 2000, the Fed quickly cut rates again in response to 9/11, moving from approximately 6% in 2001 to less than 2% in 2002.
While this was the right move at the time, the US could have taken its foot off the gas sooner as the economy restarted. However, the Fed overestimated the economy’s weakness and kept monetary policy loose for longer than needed. This led to a stronger than expected recovery and set up the economy for its next crisis, the Great Recession.
The Next One
Starting in the middle of 2007 to the end of 2009, the Fed cut interest rates by nearly 5 points to respond to the financial crisis. Once big banks were deemed too big to fail, both monetary and fiscal policy were put to use to help jumpstart the economy.
The ~5 point drop in interest rates combined with quantitative easing and accommodative fiscal policies (such as the JOBS Act) led inflation to about-face in less than a year. And after inflation was tamed, US markets experienced the longest bull run in history.
While there is no one recipe for success, the tools at hand can and have been used to steer economies. The time it takes for them to effect change, however, is not optimal. (Monetary and fiscal policy actions typically take at least 6–9 months to impact local economies). So, it’s important to take actions proportional to the economic realities we face and do it promptly.
As we approach the debt ceiling once again, more accommodative fiscal policy may be needed to account for the massive boost in money supply throughout the pandemic. It’s worked in the past and can work again, so long as it’s not overlooked until the last minute.