Probability of Recession: Is It Really One in Three?

Larry Summers recently wrote in the Washington Post:

On the current policy path, it would be surprising if growth were rapid enough to reduce unemployment even to 8.5 percent by the end of 2012…. With growth at less than 1 percent in the first half of this year, the economy is effectively at a stall and facing the prospects of shocks from a European financial crisis that is decidedly not under control, spikes in oil prices and declines in business and household confidence. The indicators suggest that the economy has at least a 1-in-3 chance of falling back into recession if nothing new is done to raise demand and spur growth.

Summer Summers is a voice to be respected. He is a top-notch economist who has served as Treasury Secretary and President of Harvard. How do I assess his view?

He's probably too gloomy. The more time people spend in Washington, they more importance they give to public policy. I'm enough of a Keynesian to think that fiscal policy matters a little, but it generally matters far, far less than newspaper headlines would suggest, and much much less than Beltway economists think.

He's right about the risk. I'm not saying the odds are 1 in 3, but what if the true odds are only 1 in 10?  I say "only" 1 in 10. You have insurance for risks far less probably than 1 in 10 (death, auto accident, fire, etc.)

What should business management due about economic risk? I've suggested a process for economic contingency planning. I suggest that every business, government agency and non-profit convene its management team and board and do some contingency planning for the possibility of another recession. However, my best forecast right now is that growth will accelerate enough to avoid a recession; not enough for us to feel good about the economy this year or next, but enough to avoid a recession. But I've been forecasting long enough to be humble about my ability to predict the next recession.