The U.S. Isn’t Prepared for the Next Recession

Maybe it will start with a failed initial public offering, followed by the revelation of widespread fraud in Silicon Valley. Perhaps energy prices will spike, sapping the finances of anyone who drives a car to work. Maybe a foreign crisis will cause a credit crunch, or President Trump will spark a global trade war. A recession might seem like a distant concern, with the latest data showing that the current, extraordinarily long expansion just keeps humming along. But one will hit eventually, for some reason or another—that’s how economies work. And when it does, the country won’t be ready.

The average middle-class household has largely recovered from the Great Recession, which began nearly 10 years ago, in December 2007. The growing economy has started to boost earnings across the income spectrum, and higher housing prices have done the same for net worth. The amount of debt that households owe is falling, too. Yet millions of people remain in perilous financial shape, with little to buffer them in the event of a layoff. Roughly half of respondents to a Federal Reserve survey conducted in 2015 said that they could not come up with $400 in an emergency, with a third saying they could not cover three months of expenses, even if they sold assets, dipped into retirement accounts, and asked friends and family for help. Outsize wealth and income continue to accumulate at the very top of the scale, and the finances of millions of American families remain fragile. Americans are no worse off than they were when the last recession hit, in other words, but a decade of growth has not made them more secure, either.

American businesses, on the other hand, have rarely had it so good. Rising demand from overseas and a weaker dollar have boosted corporate earnings across the board, so much so that four in five companies beat analysts’ earnings expectations in the second quarter—the highest share in more than a decade, Bloomberg reports. The stock market is at or near record highs, and America’s firms are sitting on trillions of dollars of cash that would help tide them over in the event of any downturn and concomitant fall in sales and profits. That said, there is no sign that businesses would use that cash to preserve jobs and help average workers. Indeed, companies would likely do what they did last time around, using a downturn as an opportunity to fire workers, pour resources into technologies that reduce the need for workers, and “upskill” their labor forces, meaning the less-educated workers who have recovered least from the last recession would again be hardest hit. The economy has had three jobless recoveries following the last three recessions, and the next recession would likely prompt a fourth.

Where things get really worrisome is the potential and likely response of the government. When it comes to monetary policy, there is far less space for the Federal Reserve to maneuver than last time around. Interest rates remain near scratch. The Federal Reserve already has trillions of dollars of assets on its books, bought as part of its policy of “quantitative easing” to depress the value of the dollar and spur investors to make riskier bets. There is still a lot that the Fed could do during a downturn, including buying up more assets. “I believe that monetary policy will, under most conditions, be able to respond effectively,” Janet Yellen, the current Fed chair, said last year. But it might not be able to respond with the force it did in the Great Recession.

As the Fed has reminded Congress repeatedly, monetary policy (basically, what the Fed does) works better when paired with fiscal policy (what Congress does). And the fiscal policy outlook is worrisome as well. Congress too has less room than it did during the Great Recession, with the country’s debt burden as a share of the overall economic output rising from 63 percent to 104 percent. That need not necessarily constrain the government’s ability to spend at a deficit—something that would help pull the economy out of any downward spiral—given how low interest rates are and how strong investors’ appetite for American debt remains. But fiscal hawks in Washington choked off debt-financed spending just months after the last recession ended, and would be likely to attempt to do the same again. Moreover, Republicans would likely push for most of a stimulus to come from deregulation and tax cuts, though research from the last recession clearly shows that spending, particularly on lower-income families, was far more effective, dollar per dollar. The broader fractiousness in American politics seems salient, as well. A Congress that cannot agree on much of anything seems unlikely to agree on a stimulus package aimed at helping America’s most vulnerable, quickly and effectively.

Unlike the federal government, states and local governments are generally required (by their constitutions) to balance their budgets each fiscal year, even during a downturn. Many try to avoid slashing services and laying off employees in the event of a recession by maintaining a rainy-day fund. Those funds are in “pretty good shape,” Tracy Gordon of the think tank the Urban Institute told me, with 28 days of expenses saved up on average. Still, that overall number hides significant variation between the states, with South Dakota flush with cash and Oklahoma’s coffers empty, for instance. Despite the current strength of the economy, a number of states, including Connecticut and Illinois, are facing ongoing budget crises, meaning that in any recession they would be forced to make yet deeper cuts. Plus, state and local government employment and investment in things like roads and police cars never rebounded from the last recession. “It is a continual worry that it never recovered,” Gordon said. “That’s a sign of continuing trouble in the water.”

Then, there is the weakness in the unemployment-insurance system, a major bulwark against any contraction in the economy, whether regional or national, since it immediately helps pay the bills of workers who were laid off. Since the last recession, numerous states have cut back on the duration and the size of benefits that recipients who pay into the system and lose their job receive. From the late 1960s through the Great Recession, every state had a maximum benefit duration of at least 26 weeks, said George Wentworth of the National Employment Law Project, a nonprofit research and advocacy group. Now, nine states offer fewer than that, with Florida offering just 12 in some cases.

“The point here is that the system’s effectiveness as an economic stabilizer has really been undermined by a lot of program cuts that have happened since 2011, mostly in response to the solvency problems that the last recession created,” said Wentworth. “Right now, one in four unemployed workers are receiving benefits. There are 15 states out there where the share of workers is less than one in five. In the southeast, the cuts have been so deep there’s barely an unemployment-insurance program there.” In the event of another recession, without strong and swift federal and state intervention, many Americans would face far less help from unemployment insurance than they did last time around, he said.

Other so-called automatic stabilizers—programs that automatically increase in spending when the economy starts to falter—seem at risk too, due to the political tides in Washington. Republicans have vowed to remake a number of safety-net programs as block grants, which would prevent them from naturally expanding as demand increased. Medicaid, for instance, would fail to automatically enroll eligible participants, as would the food-stamp program. Moreover, Republicans in the states have added a number of work and other application requirements to safety-net programs and Republicans in Congress are preparing to do the same. In a downturn, if those requirements weren’t waived, they’d prevent many workers who lost their jobs from receiving benefits.

Block-granting the programs would make them less immediately effective as stabilizers, too: As things stand now, food stamps, unemployment insurance, and Medicaid enrollments generally start increasing far before economists in Washington and analysts on Wall Street have called the start of a recession. “I don’t think that in the thought process around scaling back entitlements, block granting—that these are automatic stabilizers isn’t even a criteria in the debate,” said Mark Zandi, the chief economist at Moody’s Analytics. “It ought to be, because these are vital parts of the safety net that kick in when we go into a recession. But if we have to rely more on discretionary fiscal policy that’s deficit-financed to get out of a recession, politically that becomes a very fraught thing to do.”

Finally, there is the question of the rest of the world. Because of the interconnectedness of the global economy, were the United States to tip into a recession, other countries would likely do so too—and other countries might be yet less capable of boosting their domestic economies than the United States is now or they themselves were the last time around. That would weigh on sales for American companies offering goods and services abroad and worsen the downturn in the United States. “The European Central Bank has negative interest rates, and the fiscal situation in Europe is much more tenuous. The Japanese have absolutely no ammunition left. China used a lot of stimulus in the Great Recession, and debt and leverage is a big problem there,” said Zandi. “The U.S. is probably in better shape than much of the rest of the world.”

In terms of global circumstances, political will, and fiscal and monetary firepower, then, the next recession seems in some ways more difficult to fight than the last. That need not mean that it would be worse than the Great Recession, of course. But it does mean that it will be worse than necessary.