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7 1 The National Outlook for 2020 Jeffrey M. Humphreys, Director Terry College of Business University of Georgia The Terry College's 2020 U.S. economic forecast calls for the economic expansion that began in the second half of 2009 to continue through 2020, but we put the probability of a 2020 recession at an uncomfortably high 40 percent. Even with the Phase One trade deal, the trade war that began in 2018 is the main risk to growth. Each escalation of the trade war damages businesses' animal spirits, which leads to less capital spending and less hiring. There are no recent precedents to the current level of trade policy uncertainty. In addition to the trade war, there are several geopolitical risks capable of triggering a recession in 2020, especially a war in the Middle East involving Iran and Saudi Arabia. The baseline scenario is that U.S. economic growth slows substantially in 2020. The slowdown will be widespread both geographically and by line of business. The economic slowdown will be business led. At the time of this writing, in mid- December, the 2020 recession risk is 40 percent. Under the baseline scenario of sustained economic expansion, the annual rate of U.S. GDP growth – 1.5 percent – will be less than half the economy's long-term rate of GDP growth. It also will be below the 2.3 percent pace of GDP growth estimated for 2019. The slowdown of 2020 GDP growth to 1.5 percent will be due primarily to the direct and indirect effects of the trade war. Less support from the 2018 federal tax cuts also will slow GDP growth in 2020. The trade war is the main recession risk. Even with the Phase One trade deal, the trade war may cause a recession and any major escalation will be fatal to the U.S. economic expansion. The higher tariffs alone are not a large enough percentage of GDP to push the U.S. economy into recession, but the trade war's indirect effects are capable of pushing both the U.S. and global economies into recession. The most economically damaging indirect effect of the trade war is heightened uncertainty, which crushes animal spirits. Businesses' confidence is more sensitive to escalations and de-escalations in the trade war than consumers' confidence. Other indirect effects that damage the economy include widespread disruption of supply chains, lower equity prices, postponed decisions by business with respect to investment and hiring, and the retaliatory imposition of non-tariff barriers to trade. A full-blown currency war would fall into the latter category, but it is a very low probability possibility. The trade war already has lowered animal spirits. Indeed, uncertainty regarding a very disorganized, chaotic trade policy lowers confidence more than a more orderly and predictable approach – especially among businesses leaders, which, in turn, lowers businesses' investment spending and net hiring. At this juncture, any meaningful escalation of the trade war – perhaps even a failure to quickly and decisively deescalate – will produce more uncertainty, greater supply chain disruptions, lower confidence and reduced business investment. The upshot is that job growth slows, halts, and reverses. In essence, as the trade war escalates, the labor market weakens, and consumers' confidence falls. The combination of slower job growth, higher unemployment, less confidence, and higher prices on imported goods reduces consumer spending. Because consumer spending is the primary diver of U.S. economic growth, when it declines the record-long U.S. economic expansion ends and a recession begins. One reliable sign that a U.S. recession is underway is an increase in the U.S. unemployment rate of 0.3 percent within a relatively short time and is sustained. When the unemployment rate increases by 0.3 percent or more within a 3 to 4 months consumer confidence is likely to decline to levels at which consumers reduce spending, which, in turn, causes businesses to lay off workers. A vicious cycle begins that quickly leads to recession. It will help that the Federal Reserve reversed its monetary policy stance in mid-2019 by lowering policy interest rates and by halting reductions in the size of its balance sheet. It will help that there are not too many serious financial imbalances in the private sector. For example, household balance sheets are in great shape. Consequently, the 2020 recession is likely to be moderate rather than severe. A repeat of the "Great Recession" appears unlikely, but a relentless escalation of the trade war – and possibly a currency war – would darken the outlook considerably. The 2020 recession and the recovery in its wake may not have the typical "V" shape, but may instead look like an elongated "U." It all hinges on trade policy.

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