How the economy could head into a recession | Opinion

Federal Reserve Powell
The tax cut by the Trump administration could force new Federal Reserve chairman, Jerome Powell, to make a policy mistake and cause the economy to head into a recession.

Is too much of a good thing a good thing?

All of us have overindulged at some time in our lives, and that could be the case with the economy. Although we dream of the great things that could come from the tax cuts, there may be a dark side: Growth could become too strong. And if that happens, the golden goose just may get cooked.

The economy is in good shape as GDP grew by 2.3 percent in 2017. The pace of expansion, though, was the same as the average since the end of the Great Recession.

Yes, it was up from the 1.5 percent in 2016, when energy prices and the energy sector collapsed, but slower than the 2.9 percent posted in 2015. The economy didn’t accelerate last year. The eye-opening number was the unemployment rate, which declined from 4.7 percent in December 2016 to only 4.1 percent in December 2017. This is the lowest rate in 17 years. You have to go back to the 1960s to find an extended period where the rate was lower.

The decent growth and tight labor markets should be a good thing, and they are. But when you put on top of that a massive tax cut law that will add billions of dollars of new spending to the economy, significant risks emerge.

Normally, expansionary fiscal policy is implemented when a sluggishly growing economy needs help. With unemployment rates usually high, there are plenty of workers available, allowing businesses to expand quickly without major restraints.

The current tax cuts will hype economic growth, but in an environment where the biggest problem facing businesses of all types and sizes is the inability to find qualified labor. To meet the accelerating demand, companies will need more workers who don’t appear to be out there.

So, what will firms do? They have a variety of choices. They can work their current staff longer and harder and squeeze out more production. However, hours worked are already high. The weak productivity numbers indicate that this approach has reached the point of minimal return already.

The second option is to raise pay grades to secure the needed workers. But that would ultimately force firms to raise compensation of their current employees, as well, or risk losing them.

The third option is to hire and train “unqualified” workers. This would increase costs and lower productivity, which is already weak. In addition, many “unqualified” workers cannot pass either drug or background checks. The reserve army of unqualified, but employable, workers may be small.

The last option is to turn down business. That is hardly a desirable option, but it is already happening.

All of those options create issues for the economy and policy-makers. If domestic firms cannot, or will not, fully meet the growing demand, the goods will have to come from somewhere — most likely foreign sources. A portion of the tax cuts will go to imports, which reduces the impact of the policy.

Firms may also opt to ration the growing demand by raising prices. That would offset the higher wages and pad profits. But if that happens, inflation will accelerate. That is what concerns economists most about the timing of the current tax cuts. Rising inflation could force the Federal Reserve to hike interest rates more, and faster, than currently expected. Longer-term rates, including mortgages, would also increase to reflect the higher inflation.

And that brings us to the next recession.

Economic expansions don’t just fade away. Recessions are generally caused by either bursting bubbles or policy mistakes. In the last 20 years, we had two bubbles, the dot.com and housing bubbles. When they burst, recessions followed. In the 1970s, ’80s, and ’90s, recessions were usually brought on by Federal Reserve policy errors. The Fed would raise rates to slow growth and keep inflation in check. But monetary policy is as much art as it is science, and the resulting slowdown tended to deteriorate into a recession.

Over the next couple of years, the Fed may be forced into a monetary policy error because of the fiscal policy mistake of passing massive tax cuts when growth was solid and labor was scarce. When you implement policy, it can be as important as the type of policy you employ.

The tax cuts came at the wrong time. The economy didn’t need them; the politicians did. The seeds for the next recession have been sown. Growth is likely to be too strong for the labor market to handle. The tax cuts are likely to create too much of a good thing.