Risk of recession is low, but rising

Analysis |

Despite the problems with mortgages, credit availability and August's surprise drop in job creation, the economy is not on the verge of a recession, economists say. But the odds of a slowdown in 2008 are increasing.

Kurt Karl, chief U.S. economist for Swiss Re, puts the chance of recession at 35 percent, compared with 20 percent a month ago. Many economists agree: The risk is low, but rising. "You still have major problems in housing, and with banks tightening credit, that could scare the consumer into spending less," Karl says. "That leads to much slower growth heading into the end of the year."

Even so, Karl predicts gross domestic product will still grow at an annual rate of about 1 percent versus 4 percent in the second quarter. A recession is customarily defined as two quarters of declining growth.

Housing weakness continues to weigh on GDP, notes Ethan Harris, chief U.S. economist at Lehman Brothers. "We still have a year, year and a half to go of negative growth coming from the residential sector," he says. "Is the economy strong enough to withstand that? Yes. Are investors and consumers strong enough to withstand that? That remains to be seen."

Psychology, Harris says, will be key to continued growth. Confidence will keep banks lending and consumers spending. That, economists say, is where Federal Reserve policymakers — meeting next Tuesday — can make a difference. "The Fed is in a position where it can not only justify cutting interest rates, but it pretty much has to," Harris says. "That lets everybody know that (it is) on top of things and watching, and that's the kind of confidence boost the economy needs."