The Current, delivered daily.
The American economy is likely to enter a recession “sometime within the next two years" as the Federal Reserve fights inflation.
That’s the outlook from Larry Summers, a Harvard economist with the ear of policymakers who served as US treasury secretary in the Clinton administration and director of the National Economic Council during the Obama administration.
Speaking at the National Association of Chain Drug Stores Total Store Expo in Boston, Summers said that bringing down inflation will require slowing down the economy to the point that the US enters a recession.
“I don’t think that recession has already started. I don’t think it is in immediate prospect. But if we are going to contain inflation I have to record that I think it is likely,” Summer said.
Summers’ analysis comes as the economy deals with a bout of 40-year-high inflation following the worst of the COVID-19 pandemic. Central bankers are aiming to bring prices under control, but businesses are looking for signs of whether this will bring a downturn in the process. Many have hoped for a “soft landing” that brings only a moderate slowdown in growth, however, Summers does not believe this is in the cards.
“Economic history teaches that soft landings are like what George Bernard Shaw said of second marriage: A triumph of hope over experience,” Summers said. “The prospect that we will successfully bring this economy down in a way that will not involve a recession is not inconceivable, but I think it is odds off.”
Mistakes were made
Outlining what he called “mistakes” of the last two years, Summers laid out the case that has made him one of the most noted critics of the economic actions taken by US leaders as they sought to steer a recovery from COVID-19 at the tenuous time that preceded widespread vaccination.
Summers allowed that the initial economic response to COVID-19 in 2020 was the right one, as the federal government extended relief funds to businesses and individuals in the face of the massive downturn resulting from health restrictions, and the layoffs and pullback in spending that resulted.
“It was right to think that the risks were of not doing enough to support the economy after COVID, rather than doing too much to support the economy after COVID. That was right, but we stayed at it as a country for too long,” said Summers.
The 2021 stimulus arrived when the economy was “well on the road to recovery,” Summers said. The $2.8 trillion total of the relief packages was five times the size of the output gap recorded in 2009 at the outset of the Great Recession.
“Yes, we should have done more after the financial crisis, but no one thought we should have done five times as much,” he said.
Combine that with accumulated savings as a result of restrictions on in-person activities and the Federal Reserve holding interest rates low. “With all that flow of demand it was inevitable that the bathtub would overflow,” Summers said. The result was more money chasing goods than items available, labor shortages and a shock to supply chains. The mismatch of supply and demand led inflation to spike.
Taking the medicine
While Summers allowed that it remains a period of “enormous uncertainty,” his remarks about a recession come as central bank leaders appear to be preparing the public to batten down the hatches. In a Friday speech from Jackson Hole, Wyoming, Federal Reserve Chairman Jerome Powell warned of “some pain” ahead for households and businesses as back-to-back interest rate increases move through the economy, and more are likely to follow.
The word that is doing a lot of work there for economists is "some," as the big question lies in how much pain will ultimately be necessary.
After digging into the data and talking with leaders, Summers is not optimistic. The latest reading of the Consumer Price Index from July showed inflation at 8.5%. The Federal Reserve’s goal is to bring that back down to 2%. Summers believes that the inflation volatile CPI categories such as gasoline, food and used car prices will moderate, lowering the inflation rate somewhat in the short-term. However, he believes there is an underlying inflation of 5-6% – still well above the 2% goal.
The actions required to remove that other 3% of inflation is what will raise the unemployment rate, and slow growth. Factoring in the pandemic-era labor market phenomena of Great Resignation, a rise in vacancies and quiet quitting, Summers believes a “sustained stretch above 6% unemployment” is likely necessary to bring inflation down – well above the current 3.5%.
“I don’t think it’s realistic to think that we can keep the economy growing all the way through that, just at a slower rate, but anything is possible,” he said.
This could set up a period where actions taken by policymakers appear to run counter to encouraging a healthy economy. As interest rates continue to rise, data on unemployment and growth will likely go in the wrong direction. The Fed may get signals from businesses, the public and even other leaders that it should stop raising rates, but Summers said it must continue the hikes in the face of this, until inflation is back down around 2%. On this point, he echoed Powell, who said on Friday of reducing inflation that, “We must keep at it until the job is done.”
To explain what is necessary, Summers offered an analogy that was apt for a group of pharmacy leaders.
“When you are prescribed a course of antibiotics, it is important that you take the full course of antibiotics and that you don’t stop taking the drugs the moment you feel better,” he said.
That doesn't mean following the course is easy. Avoiding a more prolonged period of economic pain will take “will and fortitude” on the part of the Fed, Summers said. As with a shot, short-term soreness prevents long-term illness. The public must look away from the needle, and let the Fed administer the shot.
“Ironically, the greater is our determination to accept pain, the lesser is the pain that we will ultimately have to accept,” Summers said.
Trending in Economy
The retailer's marketplace is expanding quickly.
When it comes to ecommerce growth, was the pandemic a blip or a new trendsetter?
As we move further from the height of COVID-related closures, it’s a question that will start to be answered through the lens of history.
So far, the narrative of ecommerce growth in the U.S. from 2019-2022 has gone like this: Ecommerce’s share of overall retail saw a huge spike at the height of the pandemic in 2020-21, when goods in general were in demand and online shopping was necessary to preserve health and safety. Experts looked out and saw a permanent exponential change in the penetration of ecommerce as a share of retail that would last beyond the pandemic. Then, in 2022, everyone went back to stores and the trendline came back to 2019 levels. Growth was no longer exponential. There was still growth, but it was not happening as fast as during the pandemic period.
With this in mind, it’s worth pointing out that 2023 is the first year that there likely won’t be a pandemic-influenced swing to influence ecommerce growth. It is also a year where demand has suffered challenges amid inflation and interest rate hikes.
So as we seek to determine the importance of ecommerce to overall retail, it’s worth it to continue taking a close look at what growth trends retailers are seeing now, whether ecommerce is remaining resilient amid consumer pullback and how retailers are preparing for the future.
The latest example arrived this week from Macy’s. It’s a fitting one for the times. Overall, Macy’s is seeing a slowdown as consumers pull back on discretionary purchases, with sales declining 7% in the first quarter versus the same quarter of 2022. Digital sales were down 8%.
Macy’s is particularly susceptible to the macroeconomic headwinds that many brands and retailers are facing, as spending among the middle-income consumers it counts as a primary customer base is particularly softening, said GlobalData Managing Director Neil Saunders.
But while ecommerce is slowing overall, the importance it gained to Macy’s business during the pandemic is remaining in place.
In 2019, ecommerce made up 25% of Macy’s revenue, CEO Jeff Gennette told analysts on the company’s earnings call. That jumped to a high of 44% in 2020. By 2022, digital reached 33% of sales after the pandemic boom. In the first quarter of 2023, it remained at 33%. So, while the trend line dipped after shoppers returned to stores, ecommerce share still settled in at a higher post-lockdown point than it was before the pandemic.
This came in a quarter in which traffic was “relatively good” across both online and in-store, Gennette said. It was “flattish” online, and slightly up in stores.
“We do expect that this is the reset year with the penetration between them,” Gennette said. “But we do expect more aggressive growth in digital in the future versus stores as we think about '24 and beyond. And that's going to be foisted by a lot of ideas and strategies.
Over the last year, the retailer has made investments in boosting ecommerce, even as shoppers returned to stores. In a bid to boost the assortment of goods available online, Macy’s launched a marketplace in September 2022 that welcomes goods from third-party sellers.
The marketplace had an “outstanding” first quarter, said Macy’s President Tony Spring, who is poised to succeed Gennette as CEO next year. Gross merchandise value increased over 50% when compared to the fourth quarter of 2022, while the average order value and units per order for marketplace customers was 50% above those not shopping at the marketplace.
Macy’s is continuing to build the marketplace even as it racks up sales. The retailer added 450 brands, ending the quarter with 950 brands.
This is helping to draw in new customers, as well as younger existing customers who are buying more items, resulting in increased basket size.
“We're very excited as to how marketplace is really attracting the Gen Z customer, particularly in categories where it was not economically feasible for us to carry in the past,” Gennette said.
In the end, Gennette said a strong digital and social presence is key to attracting younger consumers. That's a different type of shopper than other age groups.
“We know the younger customer starts first online,” Gennette said. That behavior will still be in place as the generation gets older, and gains more buying power in the process.
Going forward, Macy’s is seeking to expand the model to other retail banners in its portfolio. Bloomingdale’s will open a marketplace in the early fall.
The Macy’s ecommerce trajectory isn’t that different from the wider U.S. ecommerce narrative detailed above. With one quarter of 2023 data, there is evidence that ecommerce share settled out at a higher point after the pandemic than where it started before COVID arrived. There is flattening now, but the retailer is taking it not as a sign of a slowdown, or a signal to change course. Rather, it sees changing consumer behavior as a reason to build for the future.