Posted by: Josh Lehner | July 14, 2022

Inflation, Recession, and Leading Indicators

Inflation continues to run very hot. Yesterday’s June consumer price index data release was larger than expected, and expectations were for a big increase given the run-up in gas prices last month. Over the past year, CPI is running at a 9% pace. This is the fastest since 1981. You can slice and dice the data myriad ways, but at a high level it is clear that underlying inflation, what you get when you start to strip out the impacts of the pandemic reopenings, overloaded supply chains and more recently the oil shock, has accelerated over the past year or so. Some relief on headline inflation is likely coming in the next couple of months as gas prices are falling today, supply chains are improving, and consumer spending on goods slows. However it is the look at the underlying trend, and to the extent it becomes more entrenched in the overall economy and inflation expectations, that is most worrisome to the Federal Reserve.

We know that inflation is not costless, and that inflationary economic booms traditionally don’t end well. The challenge is right now we have slowing economic growth combined with high inflation and rising interest rates. This creates dynamics that can lead to a recession, especially if the Federal Reserve has to continue to raise rates to head off inflation even if the economy weakens further. Given the Fed has met the employment side of its dual mandate, their entire focus is on inflation. They are actively communicating that they are willing to induce a recession if needed to ensure inflation comes down.

Anytime economists start throwing around the R word, we risk whatever comes next out of our mouths being our famous last words. So while recession risks today are uncomfortably high, it is very unlikely the U.S. economy is currently in recession based on available data which is primarily through May at this point.

Let’s first talk about what a recession is. The National Bureau of Economic Research (NBER) is the official arbiter of recessions and they define it as a broad-based decline in economic activity that lasts more than a few months. A recession is not the sometimes used rule of thumb of two quarters of negative real GDP*. Rather the NBER looks at a handful of key metrics to gauge the depth, diffusion, and duration of changes in the economy. Our office regularly updates these key NBER metrics, as seen in the first set of charts below. On the left you can see that jobs and production are continuing to increase. On the right you can see that despite the fastest inflation in 40 years, consumer spending and household income are eking out some small gains on an inflation-adjusted basis. (Note that the data here is through May, with June’s big increase in prices, we are likely to see some inflation-adjusted declines when the spending data is released later this month.) Overall, it is hard for the economy to truly be contracting when jobs, incomes, and output are all increasing in the most recent data.

UPDATE 7/15: June industrial production data was released today. It shows a decline last month, along with revisions to previous months that slow the overall growth in industrial production.

The data shown above, that the NBER uses to determine when recessions begin and end, is subject to revisions but are the best data we have showing what is currently happening in the economy. To get a better idea of what is coming in the months ahead economists turn to leading indicators.

There are two main composite leading indicator series for Oregon. The UO Index of Economic Indicators is developed Tim Duy at the University of Oregon, and the Oregon Index of Leading Indicators (OILI) is developed by our office. These indexes are red light/green light measures, so the data moving sideways is less worrisome than it may seem. What matters are outright declines on a sustained basis. We are not their yet, and the Conference Board’s U.S. leading economic index isn’t quite either.

In terms of individual components there are always ups and downs. One of the benefits of composite indices is that each individual indicator may not perfectly lead each cycle but when all the tea leaves are combined, the overall index should. Right now the indicators are a mixed bag but most point toward an ongoing expansion. The only indicator included in OILI that has truly tanked is consumer sentiment (but consumers are still spending even if they are pessimistic.) New Incorporations are slowing off of multi-decade highs and housing permits are holding steady throughout the pandemic.

Bottom Line: Based on the current data, the U.S. economy is unlikely to be in recession. And traditional leading indicator series are not plunging. Given the pessimism built into the economic conventional wisdom today, this should be comforting. However, we know the current dynamics of slowing growth, high inflation, and rising rates presents the Fed with a very challenging situation. The vibes are off. As such, our office is on Recession Watch.


Note: Keen-eyed observers may have noticed that here on the blog our office retired the COVID-19 tracking page and created a Recession Watch page last month. There is more data and detail over there. We will likely update the page once or twice a month as new data comes out.

* Let’s get this out of the way. The U.S. economy looks likely to experience two quarters of negative GDP this year. First quarter 2022 was already negative, but it’s important to note that this was due to idiosyncratic reasons. The economy did not actually contract. Consumer spending and business investment increased to start the year. However, in GDP accounting the big increase in imports, and a decline in inventories drove the overall headline numbers negative. Here in the second quarter of 2022, the expected decline — we get actual data on 7/28 — is likely to be driven again by inventory declines, but also a pullback in residential investment in the face of the mortgage rate increases, and the fact that inflation is taking a bigger bite of nominal consumer spending than it did previously. As such, a decline in the second quarter will be more of a traditional decline in GDP, and/or sign of stagflation. Again, just to reiterate, an official recession is not two quarters of negative GDP. The U.S. very likely has had two such quarters to start the year, and yet employers have added 2.7 million jobs over the same time period. This cycle is different in so many ways.


  1. Excellent analysis, very well written! How does the CPI look if our comparison period is July 2019 thru June 2022? Oh, and where did all the workers go, and can we get them back any time soon?

    • Thanks Jerry. So over the past 3 years, the CPI has risen 4.7% on an annualized basis. Core CPI which excludes food and energy has risen 3.4% annualized over the past 3 years. So with the Fed’s new framework of average inflation targeting, this could be manageable (certainly the core numbers) but of course that would be mean inflation has to slow to target (2%) tomorrow, which of course is hard to do. As for the workers, we wrote about that a bit a few months ago. The short answer is the workers have fully returned. Employment has never been higher. Now, payroll employment still has a little bit left to go because more people are self-employed and fewer are working more than one job, but there is not some pool of potential workers just sitting around any more.

  2. Again, well-written, two notes
    1) On inflation, I think the PPI at 11% (I think) is a lot more worrisome since CPI is smaller and businesses are eating in the form of lost profits. Also it needs to be “bought” back sometime or stock holders will punish them or cost-cutting will happen.
    2) I guess my vote is for a recession with ONE major exception. Unemployment is still very low. If that changes markedly the next few months of rate increases, I may be proven wrong, but I know nothing.

    • PPI can be hard to interpret in the short-term given it is so much more volatile than final consumer prices. We did see profit margins expand quite a bit during the pandemic, so some margin compression should be expected. I thought it would come from labor costs, but we shall see. Now with commodity prices tanking in recent weeks, firms will get some relief on material costs later this year.

      Avoiding a recession entirely is challenging. I’ve just thought of it as much more of a 2023 story. But the oil shock came out of the blue to start to the year and people are pessimistic and frustrated by a lot of things (economics, political, pandemic, etc). It just seems like people are jumping the gun to call one NOW NOW NOW. The data don’t support it yet! Or at least the May data and the first couple of June data releases. Even if the dynamics appear to be in place looking forward. A big part here is we have the slowing growth, but the Fed can’t really slow down to strengthen the economy because inflation is so high. On the labor front, it’s going to be interesting to watch. The unemployment rate is a coincident/lagging indicator so if it turns, then you’d think we’d know for sure. But labor is structurally tight given demographics and lack of international migration. Whenever exactly the next cycle comes it could be more of a financial market/profit losses, stagnant real personal income, but relatively mild job losses as a result.

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