Recession and Inflation

MarketWatch.com chief economist and columnist Irwin Kellner lays out a grim case for recession, or at least considerable economic softening, in his latest column. The labor market numbers he highlights can be debated, and given the government’s penchant for rather dramatic revisions in those numbers, who knows where things will settle in the end.

But where Kellner goes completely wrong is in the following:

“With consumer spending now accounting for a record 71% of our gross domestic product, it will take a whopping increase in business spending and exports to keep the U.S. economy out of recession. On the bright side, however, this developing softness in the economy will put the kibosh on rising inflation - as evidenced by the drop in oil prices over the past few days.”

History clearly shows that consumers usually follow, rather than lead economic downturns. It’s really about business investment. That makes sense. When business slows or reduces investment, and creates fewer or reduces the number of jobs, then consumers rein in spending.

As for a slower economy putting the kibosh on inflation, this is the old and mistaken Phillips Curve at work. Phillips Curve thinking pegs too much employment and/or economic growth as the cause for higher inflation. That’s incorrect. Inflation is a monetary phenomenon – as the old and true definition says: “too much money, chasing too few goods.” That’s why recessions, contrary to conventional thinking, often are accompanied by higher inflation.