Welcome back. In the past few years, the global economy has been battered by a succession of shocks, from wars and rising protectionism to a steep jump in interest rates. Fears of a recession have lingered throughout.

But history offers perspective. Excluding the pandemic, there hasn’t been a synchronised global contraction since the 2008 financial crisis. In fact, recent decades stand out for their long, uninterrupted stretches of economic growth.

In this edition, I explore why that resilience could be less reassuring than it sounds.

“Recessions have got rarer through time,” says Jim Reid, global head of macro research at Deutsche Bank. “The US has only seen four recessions since 1982. But over the previous 40 years there were nine, and over the 40 years before that there were 10. We’ve seen a similar pattern in Europe too.”

Most synchronised recessionary episodes since the 1970s have coincided with a downturn in the US, given its strong global trade and financial linkages.

The US economy was in recession for 58 months over the past five decades compared to 143 in the equivalent period prior, based on data beginning in the 1850s from the National Bureau of Economic Research.

The past five cycles of US economic expansion — including the current one that began in the aftermath of the Covid-19 lockdowns — have averaged more than eight years, which is close to triple the average length of cycles before.

On the surface, this is a good thing. Recessions drive unemployment, business closures, investment losses, social dislocation and mental stress. But are there downsides to longer periods of economic expansion?

Part of the answer lies in assessing why downturns have become scarcer.

The transition from weather-prone agriculture to manufacturing and then to services and innovative industries has made advanced economies more complex and less vulnerable to volatile supply and demand cycles.

Another factor is globalisation, which enabled the west to shift into higher value-added sectors and away from more cyclical material production. Slick global supply chains reduced the risk of shortages and supported lower prices, which meant central bankers didn’t have to tighten policy as frequently or sharply.

The rise of China and India has also acted as a motor for global growth.

Policy has played a big role, too. Across both advanced and emerging economies, policymakers have become more adept at smoothing out the macroeconomic cycle and raising economic resilience.

“Since the 1960s, countercyclical fiscal policy has been used more actively. Before that, many governments hewed to balanced-budget orthodoxy, even sometimes in huge slumps like the Great Depression,” notes Deutsche’s Reid. “Fiat money since 1971 has also provided authorities with more flexibility to manage the business cycle.”

But this is not entirely benign. Large fiscal deficits as a share of GDP had been a fleeting feature across the rich world in periods of war — now they persist in peacetime.

Higher government spending is linked to some unavoidable rising demands on the state, such as demographics, health and defence. But, as I examined in the August 17 edition, it also reflects democratic dynamics, including a higher political willingness to provide economic assistance and the public’s greater expectations for it.

In particular, recent crisis firefighting — from the pandemic and regional US bank collapses in 2023, to the European energy price shock — has normalised emergency fiscal and monetary support (such as quantitative easing and lower rates).

It’s no coincidence that some of the longest economic cycles and bull markets have come in recent decades, when deficits and bloated central bank balance sheets have been most persistent.

What’s the upshot?

First, with debt-to-GDP ratios and borrowing costs already elevated across advanced economies, the wriggle room for further support is limited, notes Deborah Lucas, professor of finance at the Massachusetts Institute of Technology.

“The risk is that future large shocks could be more disruptive and protracted because governments are no longer able to inexpensively tap debt markets to pursue aggressive countercyclical policy,” she says.

Adding to the debt pile also raises the risk of ructions in bond markets.

Next, there are financial stability hazards. Long expansionary periods support the build-up of risk, overconfidence and debt in markets.

A May 2024 paper by John Cochrane and Amit Seru, senior fellows at the Hoover Institution, argues that the expectation of central bank support should conditions deteriorate also inflates stock prices, fuels leverage and, in turn, raises risks of self-reinforcing monetary policy interventions and taxpayer-funded bailouts.

Herding incentives shouldn’t be underestimated either, adds Lucas. “If financial mangers jump out of the market early and prices keep going up, customers will go elsewhere. But those that take a big loss during a crash can at least say everyone was wrong.”

Right now, analysts point to a number of signs of excess. This includes the rise of crypto treasury companies, circular funding among tech companies, meme stocks and the rising role of debt in the data centre build-out. There are also concerns about mispricing in less transparent private equity and debt markets.

Most prominently, the AI frenzy has led to stretched equity market pricing and high concentration.

“It feels to me much like it did before the 2007-8 crisis: a lot of well-informed people are quietly talking about overvaluations, while still maintaining large exposures and privately praying for a soft landing,” says MIT’s Lucas.

Ultimately, the longer markets rise, the further they can eventually drop, and the greater any fallout may be. Deutsche research shows that when the S&P 500 has sold off notably more than 10 per cent, it has tended to coincide with a recession.

Another potential threat is to creative destruction and productivity.

Long periods of growth and economic support can keep capital and workers locked in less productive parts of the economy. In this way, recessions can be “cleansing”, notes Ufuk Akcigit, professor of economics at the University of Chicago.

“This works best when credit continues to flow to high-potential firms, and the bankruptcy and restructuring of less productive ones work quickly,” he says. “It also helps when policy helps workers move through retraining and job search, rather than freezing specific firms in place.”

In practice this doesn’t happen during all downturns, and some, such as the GFC, can impede reallocation, notes Akcigit.

The rising prevalence of zombie firms and concerns around zombie PE funds underscore fears about misallocated resources.

In turn, as I noted in the June 15 edition of this newsletter, measures of business dynamism, including rates of firm entry and exit and job reallocation, have weakened in advanced economies over the past few decades.

There are multiple drivers for this, including strategic entrenchment by incumbents. But benign economic conditions and access to multiple credit lifelines, including through private markets, also play a part in propping up weak firms and sapping growth.

Recessions aren’t a necessary condition to fix these downsides. Fiscal discipline, market corrections and prudent supply-side policy can help.

Nor are downturns extinct. Emerging financial risks and rising government borrowing may yet sow the seeds of the next crisis.

But just as recessions don’t guarantee “cleansing”, long expansions aren’t always a sign of dynamism. Downturns are painful. Avoiding them comes at a cost, too.

Food for thought

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Free Lunch on Sunday is edited by Harvey Nriapia