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Practical Economics

3 Factors That Could Drive the Next Recession

The economy is humming along nicely, but how long can the good times continue?

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The economy is humming along nicely. 2018 is on track for the best GDP growth since 2015. The unemployment rate is at its lowest level since 2000. Both business and consumer confidence are strong. But how long can the good times continue?

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The current expansion is far from over. At nine years and counting, it now ranks as the second-longest stretch without a recession of modern times, still short of the 10-year expansion of the roaring 1990s, which it will surpass next year.

Barring some sort of sudden catastrophe — the outbreak of war, natural disaster, terrorism — expect it to last at least another couple of years. The factors currently boosting the economy — tax cuts, higher spending by Congress, solid overseas growth — still have room to run. Mounting friction over trade is a worry for the economy, but not a mortal threat. The risk of a new financial crisis and a replay of 2008 looks low; the financial system is more resilient now.

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A few years out, the danger will increase. Think 2020 or 2021. Looking that far ahead is always hard, of course. But there are sound reasons for thinking the next recession could rear its head sometime early in the next decade. Here’s how that could unfold:

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1) Today’s tight job market threatens to hike inflation a few years down the line. With labor so scarce, pay is perking up — good for workers, of course, and also good for consumer spending. But big wage gains can spur higher prices of everything else.

2) Rising inflation will put the Federal Reserve in a bind. The Fed already plans to keep raising its interest rate — two more quarter-point hikes this year and three in 2019. But that’s assuming inflation behaves. As rising wages start to push prices higher, central bankers will be under increasing pressure to jack up interest rates faster. The Fed may find itself lifting interest rates at a bad time.

3) The benefits to the economy of last year’s tax overhaul and the two-year spending increase that Congress passed earlier this year will have largely run their course by 2020. In other words, there will be less oomph for the economy coming from Washington. The odds of passing new, economy-boosting legislation in an election year are low.

Tighter money and less spending by Uncle Sam are a recipe for recession. The Fed can reverse course and slash interest rates if it sees lending drying up and business suffering from weaker sales. But by that point, it may be too late.

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Stocks would likely start sliding several months before the downturn — the historical pattern of market declines that go hand in hand with recessions.

The good news: The next recession should be fairly mild, not wrenching, like the Great Recession, with its toxic mix of financial crisis and housing crash. Fortunately, such economic wrecking balls come along only once in a great while.

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