Improving U.S. economic data, including today's strong personal income and spending report, has economists cranking up their forecasts for GDP growth.However, the economy is nevertheless fragile and the risk of a recession is always within sight.
But what could cause the economy to tip into recession?
Some think that it could be premature tightening by the Federal Reserve. Or spillover from the euro crisis. Or a hard landing in China. Or turmoil in the Middle East.
Gluskin Sheff economist David Rosenberg thinks it won't be any of those. Rather, he thinks if we slip into a recession, it'll be Washington's fault.
From Rosenberg:
So the question is will we get a recession or won't we? Everything else is background noise. Well, there is no chance the Fed is going to be raising rates, let alone inverting the yield curve any time on the horizon. So if there is going to be a downturn, it is going to have to come from some exogenous negative shock — keeping in mind at the same time that there is precious little cushion with an underlying GDP trend of 1.5%. I don't see it from Europe, or China, or the Middle East for that matter. Housing is not capable of relapsing given its still-depressed state. The latest Fed loan officer survey does suggest that credit is available for creditworthy borrowers (the ones that actually don't need the debt.), so it hardly seems likely that we have a credit event on our hands. *If there is a risk, it is probably on the fiscal front an that policymakers pull off some sort of 1937-38 stunt (the FDR recession) or the premature sales tax hike in Japan in 1997-98 which sent the economy back into a tailspin*.
If in fact we avoid a fiscal mistake, then the risks of a recession go down sharply (some Fed district banks peg the odds at a mere 6%) and what we are left with is what we have had all along, which is a muddle-through post-bubble deleveraging economy...
Policymakers will tighten fiscal policy and raise taxes in an effort to address budget deficit issues. However, if they do this when the economy is weak, they risk pushing the economy right into recession, which would actually decrease tax revenues and cause budget deficits to rise.
Here's a chart from Nomura's Richard Koo that Business Insider's Joe Weisenthal frequently references to demonstrate this point. Rosenberg refers to the Hashimoto fiscal reform. As you can see, tightening actually causes revenues to fall and deficits to expand:
*SEE ALSO: Wall Street's Brightest Minds Reveal The Charts That Worry Them Most >*
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