Here’s why the U.S. economy shrinking in the 2nd quarter may not be so bad

The government’s announcement Thursday that the U.S. economy had two straight quarters of no growth set off new fears about an impending recession, but for most Americans, there was underlying good news mingled with the bad.

That’s because the slowing economy signals that the Federal Reserve’s campaign to curb inflation by raising interest rates, coupled with other developments here and abroad, may be starting to work.

And although recessions usually bring higher unemployment, a far greater number of workers and families suffer from inflation.

Also there’s good reason to think that any recession-related layoffs won’t be as bad this time around, especially if the downturn is relatively mild and short-lived, as most economists predict.

Moreover, many Americans will enter any recession with higher-than-usual savings, and the labor market remains strong, despite a smattering of layoffs across the country. Thursday’s economic report showed rising incomes and a still-solid savings rate of 5.2% in the second quarter.

The official designation of a recession is made by a special panel of experts, who consider several other factors besides quarterly growth, including employment, income, spending and industrial production. Their decision will not come for some months, perhaps longer if the data are clouded.

But Republicans lost no time in renewing their accusations that President Biden and other Democrats have mismanaged the economy, pointing to one popular definition of recession as being two consecutive quarters without any growth in gross domestic product.

“Since President Biden took office and the Democrats took control of Congress, we’ve been in an all-out economic tailspin,” said Sen. Steve Daines (R-Mont.).

Such criticisms, and the White House’s staunch denials that the economy is in a meltdown, are certain to continue in the months leading to a midterm election that will determine which party controls Congress.

Beneath the political rhetoric, there’s some truth in both sides’ claims. Most economists are predicting a moderate recession at some point.

Although recessions are rarely viewed as positive, they are a regular feature of the U.S. economy, with one on average every 6½ years since 1945.

What complicates things this time is the fact that inflation has erupted at the fastest pace in decades.

A moderate recession that raises unemployment by a percentage point or two from the current 3.6% is likely to cost on the high end around 3 million jobs.

But the U.S. workforce numbers around 160 million people, so only a small fraction will be in danger of unemployment.

Inflation and surging prices, on the other hand, hurt all but the richest members of society.

Federal Reserve Chair Jerome H. Powell said as much Wednesday when he announced another big interest rate hike and signaled more to come as the central bank tries to beat back inflation that climbed to a four-decade high of 9.1% in June.

Even if the Fed’s tightening of financial conditions sends the economy into recession, causing unemployment to rise and creating other financial hardships for some, Powell said choking off inflation would be a plus for everyone as it’s a crucial precondition for stable and sustainable growth.

“Price stability is really the bedrock of the economy,” he said. “Nothing in the economy works — the economy doesn’t work for anybody without price stability.”

Powell said he didn’t think the economy was currently in a recession, especially because of the robust labor market.

“You know, 2.7 million people [were] hired in the first half of the year. It doesn’t make sense that the economy would be in recession with this kind of thing happening,” he said.

And with still nearly two job openings for every unemployed person, Powell suggested that job losses may not be large compared with prior recessionary periods. “This time could be different,” he said.

At the moment, based on the report Thursday from the Commerce Department, the economy seems to be gliding along the edge. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, slowed but still increased modestly over the second quarter. People spent less for home furnishings and clothes, but more at hotels, restaurants and other services.

Were it not for the fact that companies stockpiled fewer goods, which in part was due to persistent supply constraints, the economy would have posted a small positive number for the spring quarter.

Still, the effects of the Fed’s rate hikes and high inflation are clearly taking their toll. The data reflected “a noticeable deceleration of economic activity in the real economy due to a weakening of domestic demand and the combined impact of an energy shock, inflation and rising rates,” said Joseph Brusuelas, chief economist at the accounting firm RSM.

Thursday’s report showed that the nation’s GDP, the broadest measure of economic activity, declined at an annualized rate of 0.9% in the second quarter, dragged down by smaller inventory buildup but also a falloff in housing and other business investment and government spending.

That came after a bigger 1.6% drop in the first three months of the year.

Last year GDP expanded at an exceptionally rapid pace of 5.7%, the fastest since 1984, as the economy bounced back from the brief plunge caused by the pandemic.

Most economists agree that there isn’t yet the significant broad-based drop-off in economic activity that would mark an official recession.

The Biden administration has pushed back against Republican attacks on its handling of the economy, but the party in power, and the president in particular, traditionally carries the political burden of responsibility.

Beyond the political chest-beating and the academic debate among economists, the reality is that the American economy is still grappling with COVID-19 pandemic-induced shocks.

And if the forecasters are right and a recession is mild — and inflation is tamed — over the long haul, that should bring more good than bad for most people.