February 5, 2008 / 10:40 PM / 9 years ago

U.S. recession could be worse than recent downturns

5 Min Read

<p>A trader works on the floor of the New York Stock Exchange February 5, 2008.Brendan McDermid</p>

WASHINGTON (Reuters) - The chances of the United States avoiding a recession appear to be growing dimmer by the day, and any contraction in the economy will likely last longer and be more severe than other downturns in the past 20 years.

Recent reports have shown the housing market slump and rising defaults in the mortgage market are now taking their toll on job growth and on the manufacturing and services sector.

But heavy consumer debt, a growing federal budget gap, and rising prices could make any recession worse than Americans have experienced over the past two decades.

"If we do go into recession, it's going to be more severe and long-lasting than the last one," said Jeffrey Frankel, a Harvard professor and member of the private-sector panel that dates U.S. recessions.

The nation's last two recessions, in 1990-1991 and 2001, each lasted for just eight months.

But the two downturns that ended in 1975 and 1982, when economic conditions bore some similarities to today, each lasted 16 months, making them the longest recessions since the Great Depression of the 1930s, according to the National Bureau of Economic Research, the accepted arbiter of U.S. recessions.

The U.S. economy entered the recessions of 1975 and 1982 saddled with huge government budget deficits from spending on social programs and the Vietnam war, and was suffering double-digit consumer price inflation.

Frankel said members of NBER's business-cycle dating panel have been in contact with each other over the prospect of a recession through e-mails, but it would likely take months, or perhaps even more than a year, for the panel to determine whether the economy had turned down.

Even though the latest data showed a loss of jobs in January, and the largest monthly decline on record in an index of service-sector activity, Frankel thinks a recession is not yet at hand. "My description is that we are teetering on the edge," he said.

Will Tools Work?

Some economists warn against counting on government spending and lower interest rates, the tools commonly used to battle recession, because the fiscal deficit is already large and consumer price inflation rose to its highest level in 17 years in 2007.

"So far, the Federal Reserve has been having a lot of luck," said Eugenio Aleman, senior economist at Wells Fargo in Minneapolis, but Aleman thinks inflation will tie the Fed's hands.

"But the Federal Reserve will be pushed to increase interest rates and then we are going to go into a true recession, a longer recession than what we are expecting today," he said.

The main factor keeping overall inflation high has been soaring energy prices, the largest single driver of inflation over the past year. Crude oil prices reached a record $100 a barrel last month.

"I would be happier to see if we got a real break on oil prices and that's not happening and that's a little bit disconcerting," said Bernard Baumohl, managing director at The Economic Outlook Group in Princeton Junction, New Jersey.

While the central bank has said it expects inflation to moderate, there are signs lofty energy prices have begun to filter through to prices more widely.

The government said last week that the Federal Reserve's favorite inflation gauge, the core price index for personal spending excluding food and energy, rose 2.2 percent last year, above the 2.0 percent ceiling seen as the top of the "comfort zone" for the index.

At the same time, the government's budget is moving further from balance. On Monday, President George W. Bush released a budget plan that would see the U.S. deficit widen to $410 billion for the current fiscal year and $407 billion for fiscal 2009, not far from the record hit in fiscal 2004.

The last time the economy moved into recession, in 2001, there was a budget surplus, providing an opportunity for extra government spending to boost economic growth.

In addition, consumers were not as heavily in debt and credit was more freely available.

Consumer spending represents for roughly two-thirds of total U.S. economic output and for the 2007 year consumer spending grew at the slowest pace since 2003.

"My biggest concern right now is the consumer. The consumer is highly levered and when the economy faces a credit crunch on in a highly levered scenario, then you have trouble," warned Aleman.

Reporting By Joanne Morrison; editing by Clive McKeef

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