Global crash fears as virus hammers US economy
Do many rate hikes mean a global recession has begun? Here's how you can find out Image Credit: Pixabay

On Wednesday, the world's largest economy, the US, sent a sobering message after it announced its latest big interest rate hike: It plans to keep raising rates as long as it takes to conquer the worst inflation bout in decades - even at the risk of causing a recession in the process.

Its aggressive pace of rate hikes will increasingly make borrowing and spending costly for consumers and businesses. However, with plentiful job openings - most economists say a recession seems months away, at least. But most of them nevertheless think a global economic downturn is inevitable.

Do global economic declines imply a recession?

Six months of contraction is a long-held informal definition of a recession. Yet nothing is simple in a post-pandemic global economy in which growth is negative but the job market strong. The global economy's direction has confounded policymakers and many private economists worldwide since growth screeched to a halt in March 2020 as COVID-19 struck.

Inflation, meantime, has hit its highest level in decades in many countries, though fuel costs and other prices have eased in recent weeks. Inflation is still so high that despite pay raises many workers have received, purchasing power is eroding in the world's households. 

Compounding those pressures, alongside other central banks worldwide, the US is jacking up rates at the fastest pace since the early 1980s, thereby magnifying borrowing costs for homes and cars and credit card purchases.

inflation allowances
Inflation, meantime, has hit its highest level in decades in many countries, though fuel costs and other prices have eased in recent weeks.

So how, exactly, do we know when an economy is in recession? Here are some answers to such questions:

Who decides when a global recession has started?

Recessions are officially declared by a committee of noteworthy economists who defines a recession as "a significant decline in economic activity that is spread across the economy and lasts more than a few months."

The committee considers trends in hiring as a key measure in determining recessions. It also assesses many other data points, including gauges of income, employment, inflation-adjusted spending, retail sales and factory output. It puts heavy weight on jobs and a gauge of inflation-adjusted income.

Yet the committee typically doesn't declare a recession until well after one has begun, sometimes for up to a year. Economists consider a half-point rise in the unemployment rate, averaged over several months, as the most historically reliable sign of a downturn.

Two quarters of economic contraction equal a recession

That's a common rule of thumb, but it isn't an official definition.

Still, in the past, it has been a useful measure. Michael Strain, a US-based economist, has noted that in each of the past 10 times that the US economy shrank for two consecutive quarters, a recession has resulted.

Still, many economists doubt that we're in a global recession now. For one thing, there's the robust job market. For another, people worldwide are still spending, if more tepidly. Though purchases of goods like appliances and furniture have dropped, spending on services, like airline trips and dinners out, keeps rising, indicating that millions of consumers are venturing out more.

No one knows whether raising rates will lead to a recession, or if so, how significant that recession would be. That's going to depend on how quickly we bring down inflation

- US Fed Chair Jerome Powell

Don't a lot of people think a recession is coming?

Yes, because many people now feel more financially burdened. With wage gains trailing inflation for most people, higher prices for such essentials as fuel, food and rent have eroded spending power of people in most countries.

Higher rates will likely weigh on businesses' willingness to invest in new buildings, machinery and other equipment, globally. If companies reduce spending and investment, they'll also start to slow hiring. Rising caution among companies about spending freely could lead eventually to layoffs. If the economy were to lose jobs and the public were to grow more fearful, consumers would further reduce spending.

What are some signs of an impending recession?

The clearest signal that a recession is underway, economists say, would be a steady rise in job losses and a surge in unemployment. In the past, an increase in the unemployment rate, on average over the previous three months, has meant that a recession will soon follow. Many economists are monitoring whether layoffs are worsening.

UAE firms looking to hike salaries over high inflation; pay rise, salary hike
Many economists also monitor changes in the interest payments, or yields, on different bonds for a recession signal known as an "inverted yield curve".

Any other signals to watch out for?

Many economists also monitor changes in the interest payments, or yields, on different bonds for a recession signal known as an "inverted yield curve". This occurs when the yield longer-term government bond falls below the yield on a short-term one. That is unusual. Normally, longer-term bonds pay investors a richer yield in exchange for tying up their money for a longer period.

Inverted yield curves generally mean that investors foresee a recession that will compel economies globally to slash rates. Inverted curves often predate recessions. Still, it can take 18 to 24 months for a downturn to arrive after the yield curve inverts.

For many weeks, the yield on the short-term government bonds has exceeded the yield of the longer-term bonds, suggesting that markets expect a recession soon. Many analysts say, though, that comparing the short-term yield to the long-term bond yields has a better recession-forecasting track record. Those rates are not inverted now.

Will economies keep raising rates amid a slow down?

The global economy's flashing signals -slowing growth with strong hiring - have put central banks like the US Federal Reserve in a tough spot. Fed Chair Jerome Powell was earlier aiming for a "soft landing", in which the US economy weakens enough to slow hiring and wage growth without causing a recession and brings inflation back to the targeted range.

But Powell has acknowledged that such an outcome has grown more difficult to achieve. Yet on Wednesday, he made clear that the Fed will keep raising rates, even amid a weakening economy that could slide into a recession, if that's what's needed to tame inflation.

"No one knows whether this process will lead to a recession, or if so, how significant that recession would be," Powell said at his news conference. "That's going to depend on how quickly we bring down inflation."