The Length of the Coming Recession

I was in the Air Force stationed in Tucson, Arizona, in 1971. The Air Force let me take courses at the University of Arizona. I took a macroeconomics course from a young assistant professor named Frank Alessio. Best teacher I ever had. One of my fellow students was a very smart guy named Rick Kinonen. Rick and I studied macro together. He was really like a tutor for me.

I thought macro was very complicated, but Frank and Rick were patient fellows and helped me to learn it and remember it in ways I will never forget. There are two parts of the macro analysis that are useful for today’s topic. First is the difference between short-run and long-run in macroanalysis. Second is something called the multiplier analysis.

Let’s take the multiplier analysis first. This analysis stems from the idea that macroeconomic events roll out in waves. When the coronavirus first hit us, we tried to stay inside and we reduced what we bought – fewer vacations, fewer airline trips, fewer trips to restaurants, etc.

Wave 1 – virus impacted people who bought less from Macy’s, Alaska Air, Tacos Guaymas, Motel 6.

Then what? When employment and incomes of those firms and their employees was reduced, the people at Macy’s, Alaska Air, Latona Pub, and Motel 6 had less income, and they bought fewer groceries, less clothing, cars, houses and so on.

Wave 2 – now the sales of a broad swath of companies was reduced. 

And guess what? The incomes of their owners and workers got reduced, and they will spend less at wherever they shop.

Wave 3 – another drop in sales to even more companies.

Each wave’s impact will get smaller and smaller and eventually become negligible.

The sum of the impact on spending and income of all the waves is the total short run impact of the original drop in spending caused by the virus.

How long does all that take? We don’t know. We don’t know the length of the short run. Call it a year if you want to. But the point is that the negative economic impact is not going away tomorrow. All those waves are going to hit the shore.

Okay, so that’s the short run. Isn’t that bad enough? Nope.

The short-run analysis does not take into consideration a few things. It ignores whatever changes might be happening with respect to expectations of future wages and inflation. Wages and prices are often slow to change. Worker contracts help to slow the process. A weak economy often means that wages and prices will fall or at least slow their rise. But the results depend on which one of the two falls the most. If prices fall more than wages, this will hurt company profits and be another negative shock to the economy. If wages fall more than prices this will help firms but their employees will find the buying power of their paychecks falling. 

Short-run analysis also leaves out changes in productivity. If companies during a recession put off or cancel orders for new equipment or perhaps reduce their training budgets, this would reduce productivity, profits, and would cause a further contraction in output and income.

I see you are starting to fade. Don’t you just love macro!

This is why I needed so much help from Frank and Rick. But it is also pretty intuitive. Much is going to happen and so far about all we have heard is stories about how the virus is affecting spending. There are many more shoes to drop in both the short run and the long run. None of these bode well for a quick return to positive economic growth.

Can or will the newly announced stimulus packages offset these future waves? Maybe somewhat. But sadly our national debt was so high BEFORE all this started that the prospect of a huge increase in debt jeopardizes the benefits of the stimulus. I guess we will see.