Excellent article showing how uncertainty ripples through an economy

 Apr 9, 2025 9:16 PM GMT

How Economic Uncertainty Can Lead To Recession

• Politics
• Economy

by

Alana Semuels

Senior Correspondent

Traders work on the floor of the New York Stock Exchange during morning trading on April 01, 2025 in New York City. Michael M. Santiago/Getty Images

After two years of doing their own back-breaking yard work on their acre-and-a-half property in Cold Spring, N.Y., Renata Kero and her husband were ready to finally give in and spend a few thousand dollars to hire a landscaping company.

Then they started re-thinking the purchase, given the uncertainty roiling the economy. Tariffs are being levied and reversed. The federal government is cutting jobs across the country. The stock market is historically volatile. It seemed like any kind of big expenditure was not a good idea.

“It feels like the Wild, Wild West every time you open the news,” says Kero, a 45-year-old freelance journalist with a 5-year-old son. "I feel a very real sense of instability and volatility, like who knows what economic pitfalls await us."

Families and businesses across the U.S. are pulling back on spending amid President Trump’s trade war and abrupt reversals, including Wednesday’s announcement that he would pause the sweeping reciprocal tariffs he announced just days earlier, while ratcheting up levies against China even higher. As an index that measures economic policy uncertainty spikes, consumer confidence fell for the third straight month in March; it’s down more than 30% from November, according to the University of Michigan Survey of Consumers. Consumer spending fell for the first time in two years in January.

Read More: Trump Wants to Spin His Tariff Pause As a Win. It's Not.

Businesses are worrying, too. Delta CEO Ed Bastian said Wednesday that because of “broad economic uncertainty around global trade,” revenue might fall in the current quarter. Bastian predicted a recession might come soon, echoing the words of JP Morgan Chase CEO Jamie Dimon. FedEx lowered its full-year profits and revenue forecasts on March 20, citing “weakness and uncertainty” in the economy. And Warner Bros. Discovery has reportedly advised staff to cancel all “non-business critical” travel due to economic uncertainty. 

Small-business optimism declined in March, according to the National Federation of Independent Businesses, which also said its uncertainty index decreased. New policies have “heightened the level of uncertainty among small business owners,” NFIB chief economist Bill Dunkelberg said in a release. “Small business owners have scaled back expectations on sales growth as they better understand how these rearrangements might impact them.”

Uncertainty makes businesses uncomfortable because they don’t know what conditions they will be operating in. Once economic trends and policies are clear, they can adjust. But if those policies keep changing, they can’t respond or plan, so they reduce spending and avoid making major moves until conditions stabilize. Consumers pull back amid uncertainty too, putting off big purchases because they don’t know if they’ll have a job, how mortgage rates will respond to whiplashing policy decisions out of Washington, or what their investment portfolio will look like in a few months.

When consumers and companies pull back on spending, GDP turns negative, which leads to a recession. Uncertainty causes “precautionary reductions in spending because of the lack of clarity and difficulty in terms of forecasting where we're going,” says Laura Jackson Young, an economics professor at Bentley University who has studied the economic effects of uncertainty.

Trump’s moves have created a moment of acute uncertainty, and Young’s research suggests that makes people and businesses even more cautious. Her work found that when uncertainty is already high, people pay even more attention to “uncertainty shocks”—big changes that cloud the horizon even further. “When everything's okay and we're in tranquil times when nothing's really outlandish, people don't pay as much attention to that uncertain component,” she says. “Whereas in an environment where uncertainty is already pretty high, we're very attentive to something that's going to spike uncertainty, and it has a more pronounced effect.”

Read More: World Leaders Scramble On Trump's Tariffs.

Businesses are feeling this profoundly. TJ Semanchin runs Wonderstate Coffee, a small coffee roaster in southwest Wisconsin. Semanchin started the year optimistic about the business—he’d just won a prestigious award from a coffee roasting magazine, and hoped to increase sales at his retail locations as well as chains across the country, including Whole Foods, where he sells his product.

Now he’s rethinking everything. Coffee prices are already near all-time highs because of climate conditions, and then the beans he imports from countries like Nicaragua were going to be slapped with tariffs so high that his costs would amount to about $20,000 more per shipping container, Semanchin says.

Even though Trump has now paused those higher tariffs for 90 days, Semanchin’s worries remain. He’s put off plans to buy a new packaging machine, and is reducing investment for now until the uncertainty clears. “The climate we’re in definitely has me in a more defensive posture,” he says.

When businesses and families move into the same defensive posture, it can push the economy into a recession. And when seemingly each day brings sharp new policy shifts, economists—let alone individuals trying to plan household budgets—can’t be sure what to think.

The tariff reversal “does very little to resolve the uncertainty,” says Philip Luck, director of the Economics Program at the Center for Strategic and International Studies, a Washington think tank. The tariffs might have been “bananas,” he says, but no one can really predict whether they’ll return after 90 days—or even before then.

Because of this uncertainty, Kero and her husband decided that they’d once again do their own yard work this year, no matter how miserable it is. She’s not buying a new phone either, even though it’s on its last legs. Summer travel is now out of the question. “We just need to sock away as much as we can,” she says.

Monetary policy again

 

Central bankers should enjoy their soft landing while they can – it won’t last

By hosing down the flames, central banks are very likely incubating the next mega-crisis

Jeremy Warner27 August 2024 • 3:00pm

By most accounts, an air of self-congratulation hung over last weekend’s annual gathering of central bankers at Jackson Hole in Wyoming.

Miraculously, these lords of finance had pulled off the seemingly impossible by returning inflation broadly to target without inducing a recession. In the jargon, this is known as a soft landing, and it scarcely ever happens.

The normal pattern is one of boom and bust; the economy overheats, inflation takes off, belatedly the central bank acts to cool demand by raising interest rates, the therapy is overdone, the economy slows and then stalls, business activity contracts and unemployment rises.

Many learned economists predicted just such an outcome this time around. So indeed did the Bank of England. In November 2022 the Bank’s quarterly monetary policy report predicted the longest recession in living memory; GDP was expected to contract by 0.75pc in the second half of 2022 then continue falling throughout 2023 and the first half of this year.

In the event none of this happened, despite the fact that Bank Rate quickly rose to the levels assumed in those forecasts. A very mild and short-lived recession was quickly followed by a relatively strong rebound.

A similar trajectory was followed by the US economy, where like the Bank of England, the Federal Reserve initially dismissed the spike in inflation as “transitory” before belatedly slamming on the brakes when second round effects took hold.

So here we are, with the brakes duly applied but no sign of the recession you would have expected from such a severe and rapid monetary tightening. It did not require a steep rise in unemployment, it would seem, to douse the inflationary flames.

It may, of course, still be too early to declare victory; there is a sizeable school of thought that suggests recession remains very much on the cards – it’s just on a long fuse. The embarrassing admission that the official data has overstated US jobs creation by 880,000 suggests that things are not as buoyant as assumed.

Even so, financial markets remain sanguine. After the temper tantrum of a few weeks back, stock markets are again testing all-time highs, encouraged by dovish remarks at Jackson Hole from Jay Powell, the Fed chairman. The Fed will be cutting interest rates sharply from next month onwards, he implied. It seemed to be enough to calm nerves.

Still, it is more by luck than design that things haven’t turned out a good deal worse. There is not yet enough research on precisely why and how such outcomes were avoided, but here are a number of likely explanations.

First, the inflationary surge that prompted the steep rise in interest rates was very unusual in its causes. The preceding pandemic saw governments around the world effectively close large parts of their economies down with social distancing measures.

Demand was artificially suppressed, so that when the measures were lifted, it came surging back to preceding levels into an economy where supply had been badly damaged by prolonged lockdown.

It was hard to spend on services during the pandemic, which had the effect of unduly skewing what demand there was towards goods, creating bottlenecks in supply and raising prices accordingly. Services followed suit as soon as they were allowed to open again. To compound it all, Putin’s invasion of Ukraine caused fuel prices to spiral upwards, further adding to input costs.

Once these factors had readjusted back to normal, much of the inflation began to disappear.

Second, inability to spend as usual during the pandemic led to substantial savings surpluses which cushioned consumers from the effects of rising interest rates on mortgages and other borrowing costs.

Moreover, wages quickly caught up with inflation, with the result that disposable income was largely protected from rising prices.

And third, relatively high levels of immigration – both in the US and the UK – and the fiscal stimulus of Bidenomics in the States, helped keep GDP growing, notwithstanding the severity of the monetary squeeze.

The other thing that tends to happen with rising interest rates is that it catches many parts of the financial system by surprise, sparking in hidden areas of the economy a chain reaction of insolvencies and losses which damage broader financial and business confidence.

Central banks have been busy ensuring this doesn’t happen.

At the first sign of grapeshot they are on it, underwriting depositors against loss as happened with the collapse of Silicon Valley Bank and other small US regional banks, and in the UK with the liability-driven investment crisis, when the Bank of England was forced to step in to prevent a fire sale by pension funds of UK government bonds.

In Switzerland regulators quickly organised a rescue when Credit Suisse looked as if it was going to the wall.

This is all very well, and no doubt helps protect the wider economy from the destruction of financial markets.

But interventions of this type also have the effect of suppressing an essential part of the business cycle, which is to purge the system of rotten apples so as to allow for more productive allocation of capital.

By the bye, it also adds to moral hazard. Pretty soon, investors and financiers start to believe they are guaranteed against almost any loss by central bank intervention, and you end up with something like the “Greenspan put”, named after the former Fed chairman Alan Greenspan, where finance positively expects to be bailed out.

This was also the lesson drawn by financial markets from the “dash for cash” in the early stages of the pandemic, when flight to safety prompted the widespread dumping of government bonds and money market funds in favour of pure cash.

Once again, central banks stepped in to calm the waters by buying debt and otherwise providing oceans of liquidity. It stemmed the crisis, but it also encouraged finance to believe there would always be a backstop. Leverage and other high risk forms of lending have been on rocket boosters ever since.

As Raghuram Rajan, former governor of the Reserve Bank of India, put it in a recent article: “Economic stabilisation may, paradoxically, raise the chances of financial instability”.

By constantly hosing down the flames, central banks are very likely incubating the next mega-crisis.

Not that there is any reason to believe this is imminent. A bit like the next eruption of Vesuvius, no-one can tell you when it might happen.

Worryingly, the international resolve to do much about it when it does, may be lacking next time around.

Not only has enthusiasm for the global financial reform agenda instigated after the financial crisis of 2008-10 waned, but it is also hard to imagine the world coming together as it did back then with a coordinated plan of action when the next big one hits.

Today’s world is a much-changed place, with rising geopolitical division and tension and many nations already too fiscally stretched to provide countervailing stimulus. Central bankers should enjoy their soft landing while they can; it won’t last.