Is the US heading towards a 2008-style recession in the wake of rising interest rates and tapering COVID-19 stimulus?

By Anne Lipsett

It is universally accepted by economists that at the outbreak of COVID-19 in March 2020, the United States entered into a month-long recession. While no one can accurately state that the economy is anywhere near normal now, it has been moving on an upward trajectory since it hit its trough in April 2020. Despite global lockdowns, closing businesses, and diminished consumer sentiment, the United States stock market saw all-time highs. Home sales reached record highs, commodities prices were on the rise, and the Federal Reserve (Fed) was pumping stimulus into the economy to keep it afloat. Now, with the introduction of effective vaccines, the pandemic is dwindling down and the Fed is beginning discussions on tapering the stimulus. What is left to question is whether or not we find ourselves in a similar set of circumstances as we were in the months leading up to the 2008 recession. An exploration of the events leading up to the 2008 crisis and an analysis of the current state of the economy will aid in answering the question leaving financial analysts baffled. 

The 2008 economic recession resulted in bankruptcies, lost jobs, foreclosures, and diminished faith in the US economy. The seeds of recession were sown for years leading up to 2008, beginning in the early 2000s. The Fed reduced the federal funds rate from 6.5% to 1%, making it easier for people, including subprime borrowers, to make large purchases on loans. Wall Street banks packaged them as low-risk financial instruments and created an over-inflated secondary market for these subprime loans. The US financial regulatory body, the Securities and Exchange Commission (SEC), also relaxed capital requirements for large investment institutions, allowing them to leverage their initial investments by 30 or 40 times. This, together with the predatory lending strategies employed by large banks in search of higher profits, created an unsustainable environment. By 2004, the housing market was over saturated and interest rates were on the rise, creating problems for subprime borrowers and the banks who made them the loans. Subprime lenders began to declare bankruptcy—by August 2007 the major banks began to fall, and in September 2008 the markets crashed, leading to an inevitable economic fall. 

The 2008 recession was a complete breakdown of the financial system and resulted in a complete reevaluation of the regulations in place to protect lenders and borrowers. Even over a decade on, its impact can be felt. While this was a slow moving panic, a total breakdown, and a side effect of predatory lending, there are other factors that can play into a recession.

A recession is defined as a prolonged, significant decline in economic activity that lasts for months or years. It is considered a natural part of the business cycle, but its severity is dependent on external factors. Forbes indicates that the following conditions are what make up a recession: a sudden economic shock, excessive debt, asset bubbles, too much inflation, too much deflation, and technological change. What also needs to be included is the simultaneous nature of these events to create a perfect storm that results in economic devastation. The 2008 economic recession had all of these factors. Looking forward to today’s state of the economy, does the US find itself in the midst of the storm?

Despite talk of recovery and dropping unemployment rate, economists believe people are not looking beyond these surface victories to the deeper problems at hand. Supportive fiscal policy is the driving force behind the boost in numbers, including boosted GDP and pricing numbers. David Blanchflower and Alex Bryson, both economic researchers at Dartmouth College, are noticing similar qualitative data points, such as sharp declines in the jobless rate, to those in the Great Depression. They fear that the Federal Reserve’s tapering plan is premature and they are missing critical warning signs like they did in the 1920s and 2007. Major US-based bank Goldman Sachs has cut their forecast for US economic growth for both 2021 and 2022, citing lingering pandemic-related problems and the tightening of the Fed stimulus money. Veteran economist, Patrick Artus, has noted four indicators of an impending recession. First, the debt is rising dramatically compared to GDP growth, meaning debt is outpacing the growth of revenue that the government needs to pay it off. Second, the money supply is at record highs, surpassing consumer demand; this is more commonly known as inflation. Third, asset prices are also rising too much and too quickly compared to wealth, meaning a downward course correction in prices is imminent. Prices for houses, cars, and other similar assets have grown enormously since March 2020, often surpassing the real value of the asset. Eventually, this pricing bubble will burst and the prices will revert back to their true value which will hurt the owner of the asset. Finally, he cites the more restrictive policy, like the aforementioned Fed stimulus tapering, coming in the next few months and subsequent deleveraging, the selling-off of assets and making of cuts, as the final factor leading to recession. 

Using Forbes’s definition of a recession, looking at the current state of the economy, the sudden economic shock will be the start of Fed stimulus tapering, debt is exceeding GDP growth levels, asset prices are at unsustainable highs, money supply is exceeding demand, and a course correction in pricing is imminent. While 2008 was a slow descent of almost a decade, this recession is moving quickly in the span of around two years. Beyond the time frame, the same general factors align, meaning it is more than likely the US is headed into a recession similar to 2008 by the end of 2021. 

The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.

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