We’ve all seen the media hype about the possibility of a U.S. recession, some of which implies dire consequences for all Americans.
To help cut through the clutter, Smart Business sat down with Robert Dye, senior economist at PNC, to find out more about what a recession is and how it may impact companies.
What is going on with the economy?
The strong majority of recent economic data suggest that there is increasing risk of a recession in the first half of 2008. This includes payroll employment data and housing market indicators. In fact, at PNC, we now believe that there’s a 60 percent chance that we are currently in a recession. But because of the time-lagged nature of economic data, we won’t know for sure if we’re in a recession until months after it has started.
What makes it a ‘recession’?
Traditionally, a recession is defined as two or more consecutive quarters of declining gross domestic product. However, there may be special circumstances that suggest that we are in recession even if we don’t meet the traditional definition. Over the past 30 years, there have been just four recessions in the U.S. economy, with three of them lasting eight months or less. Conversely, the economic expansions between recessions have tended to last longer.
What companies are most at risk from a recession?
During periods of recession, demand for goods and services for many industries declines, investment and hiring stall, and the unemployment rate rises. Both primary producers and service companies, like transportation providers, may experience weaker demand. And as a recession gathers momentum, consumer and business confidence typically fades, adding further fuel to the recession fire. Industries that have strong cyclical components are most vulnerable, but many industries, such as education and health care, often continue to experience solid demand.
In today’s environment, we see the greatest weakness in real-estate-related markets, including residential construction, some manufacturing industries, including automakers, and industries that support residential construction and, of course, parts of the financial services industry, particularly those financial service providers that have invested heavily in the subprime mortgage markets.
So what can be done to help promote economic growth?
As you may be aware, there are two levers being pulled to help support economic growth this year. The first lever is represented by the sizable cuts in short-term interest rates by the Federal Reserve. The Federal Reserve has dramatically lowered its Fed Funds rate, which in turn allows banks to lower their prime lending rates to their best customers. In addition to cutting interest rates, the Federal Reserve has been very innovative in developing new programs to shore up financial markets when they have shown signs of stress. Among other things, the Federal Reserve has extended its lending facilities to major investment houses and has widened the types of financial instruments that banks and investment houses can use for collateral for short-term loans.
The second lever soon to be working on the economy is the fiscal stimulus plan that was enacted by Congress earlier this year. Under the plan, individuals with annual earnings up to $75,000 will receive as much as $600. Married couples earning less than $150,000 combined will receive up to $1,200. Businesses are able to use an accelerated depreciation schedule, and small businesses have greater flexibility in writing off their expenses. Also, conforming loan limits for Fannie Mae and Freddie Mac were raised for many areas, which makes loans for higher-priced homes more affordable, thus stimulating home sales.
What happens next?
While the interest rate cuts and the fiscal stimulus package are not expected to have an immediate effect on the economy, they are expected to lead to stronger economic growth before the end of this year.
Together, we think these measures will motivate both consumer spending and business investment in the second half of this year. And we continue to believe in the long-term potential of the U.S. economy, which will emerge from this period of unsettled economic indicators stronger, just as it has done so many times before.
The material presented is of a general nature and does not constitute the provision of investment or economic advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. Opinions and forecasts expressed herein are subject to change without notice. Relevant information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy. You should seek the advice of an investment professional to tailor a financial plan to your particular needs. © 2008 The PNC Financial Services Group, Inc. All rights reserved.
ROBERT DYE is senior economist at PNC. Reach him at (412) 762-2116 or Robert.email@example.com.