Recessionary U.S. economy: How close are we to a crisis?

A recession is a period of economic downturn characterized by a decline in gross domestic product (GDP) for several consecutive months, an increase in unemployment and a decrease in business activity. The term is often alarming to economists and ordinary citizens alike because a recession affects income, employment, and the overall economic climate.

Economic worries for 2024

For much of 2024, the Federal Reserve (Fed) has tried to successfully contain inflation, which has reached record levels over the past 40 years, while avoiding a recession. However, recent weak economic data, including an unexpected rise in the unemployment rate, has heightened fears of a possible economic downturn.

According to an Aug. 2 report, the unemployment rate rose to 4.3% in July, up from 4.1% in June. This activated the so-called “Sahm rule,” an economic indicator that often predicts the onset of a recession if the three-month moving average of the unemployment rate increases by 0.5% relative to its yearly low. By the end of 2024, the unemployment rate had improved slightly. In December, the unemployment rate fell to 4.1%, easing earlier concerns.

What is the Sahm rule?

The Sahm Rule, developed by economist Claudia Sahm, is used to identify the early signs of a recession. It was originally conceived as a tool for timely government support of the economy. However, the author of the indicator himself notes that this rule is only a historical pattern and cannot take into account all the peculiarities of the modern economy. Against the background of economic changes in recent years, Sahm's rule has been criticized. For example, in the current situation the growth of unemployment rate is associated with an increase in the number of people actively looking for a job rather than with mass layoffs.

Recession management and avoidance mechanisms

Governments and central banks use a wide range of tools to prevent recession and mitigate its effects:

•   Interest rate cuts: This move reduces the cost of credit for businesses and consumers, stimulating investment and consumption.
•   Fiscal measures: Governments can increase public spending, such as on infrastructure projects, or cut taxes to stimulate economic activity.
•   Employment support: Programs that subsidize jobs and help the unemployed help to maintain income levels.
•   Financial market regulation: Central banks may intervene to stabilize the currency and provide liquidity in the banking system.

These measures are aimed at supporting the economy during recessions, minimizing their depth and creating conditions for subsequent recovery.

How does a recession begin?

Recessions can start for a variety of reasons: Financial imbalances, such as the 2008 real estate market crisis, or economic shocks, such as the 2020 pandemic. At this point, the main risk factor for a recession is tight financial conditions. The Federal Reserve raising interest rates to levels not seen in 23 years has been a major hurdle for borrowers, both individuals and businesses.

If such conditions lead to a decline in investment and consumer spending, it could be a trigger for an economic downturn. Economists also note that lower business and consumer confidence has the potential to amplify the effects of financial pressures. By the end of 2024, the Federal Reserve had cut the benchmark interest rate three times, bringing it to a range of 4.25-4.5% per annum, which helped to partially ease financial pressures.

Next steps for the Federal Reserve

The Federal Reserve continues to take a flexible approach to monetary policy in early 2025. The focus is on reducing inflation, which remains above the 2% target. Economists predict that the Fed will keep interest rates at the current level of 4.25-4.5% in the coming months to balance economic growth and inflation. However, Trump, in his first days as president, has already criticized the Fed's strategy and called for an interest rate cut.

Recent data show a steady decline in jobless claims, which is boosting confidence in the labor market. Nevertheless, financial conditions remain challenging for some sectors of the economy, prompting the Fed to remain cautious in its actions. Forecasts for 2025 remain moderately positive: experts expect the US economy to continue growing, albeit at a more moderate pace. Inflation is likely to remain above the Fed's 2% target, which will require additional monetary policy adjustments.

Conclusion

Recession risks remain, but current economic data does not yet suggest that a downturn is imminent. In the coming months, the key factors will be the Fed's actions, inflation dynamics and changes in the labor market.