The odds are high that the United States economy will sink into a recession sometime within in the next year, according to a former chief economist for the International Monetary Fund.
“A recession at the end of the year or early next year is a better even money,” said Maurice Obstfeld, a professor of economist at University of California Berkeley and a former chief economist at the International Monetary Fund, in an interview with MarketWatch on the sidelines of the Federal Reserve’s summer retreat in Jackson Hole.
On Friday, Fed Chairman Jerome Powell said the U.S. would likely experience below-trend growth as the central bank raises its benchmark interest rate to try to bring inflation down, but avoided using the word recession.
Powell started making the case that households would experience “pain” from the tightening but he didn’t quite refer to “blood, sweat, and tears” than may be coming, Obstfeld said.
Consumer inflation is running at an 8.5% annual rate, the highest levels seen in forty years.
At the same time, the U.S. labor market is strong, with the unemployment rate at 3.5% and wages rising at over a 5% annual rate.
Economists stress that the Fed needs to cool the labor market down in order to get inflation under control.
But this won’t be easy, Obstfeld said.
“The labor market has a lot of momentum. We probably have to see further significant hikes in the federal funds rate to get it down,” he said.
Obstfeld said that the Fed’s benchmark rate will likely have to move up to a 4.5%-5% range.
At the moment, the Fed’s benchmark interest rate is in a range of 2.25% -2.5%.
In essence, there is a risk the Fed will have to slam on the brakes of the economy to get inflation down.
If this happens, it is doubtful that the unemployment rate will only rise to 4%, Obstfeld said
The recession could be shallow, similar in a way to the economy in the wake of the Sept. 11, 2001 attack on the World Trade Center.
It turned out that the economic downturn in the wake of that attack “wasn’t that bad,” but it did take the labor market a long time to recover, he said.
Stepping back, the economic outlook is highly volatile and it is hard to know which way events will unfold, Obstfeld stressed.
It itself, the dispersion of outcomes is weighing on business and consumer confidence, Obstfeld said.