Countering these powerful downward economic pressures are strong export growth (up at a 16 percent annual rate in the third quarter) and increased federal government spending (up 7 percent). The economy's fate hangs heavily on the outcome of this tug of war. Meanwhile, what's missing from all the agonizing about a possible recession is a sense of proportion.

Of course, no one likes the usual side effects of a recession: higher unemployment, weaker profits, more stress. Still, popular rhetoric exaggerates the damage. By and large, recessions are problems, not tragedies. Since World War II, there have been 10 of them, or one about every six years. On average, they've lasted 10 months (indeed, a common definition of a recession is at least two quarters of declining output, though the actual dating of business cycles is done by a committee of economists). Disregarding two severe recessions—those of 1973–75 and 1981–82—peak monthly unemployment has averaged 7.1 percent.

Recessions also have often-overlooked benefits. They dampen inflation. In weak markets, companies can't easily raise prices, nor workers' wages. Similarly, recessions punish reckless financial speculation and poor corporate investments. Bad bets don't pay off. These disciplining effects contribute to the economy's long-term strength, but it seems coldhearted to say so because the initial impact is hurtful. Today, a U.S. recession might also reverse the upward spiral of oil prices and trigger a faster—and healthier—drop in home prices. As economist Berner notes, the slow decline in prices prolongs the housing slump, because it induces "would-be buyers [to] wait for more attractive deals." By making homes more affordable, a quick and sharp price drop might revive housing more rapidly.

"Moral hazard" is now a much-bandied-about phrase. Its initial meaning stems from insurance: if you overinsure someone against risk, you may encourage undesirable behavior. Example: cheap flood insurance will spur home building along vulnerable coasts. The Fed faces a similar problem. If it tries too hard to prevent re-cession—through easy-money policies—investors, businesses and workers may conclude they have nothing to fear. They may then engage in precisely the risky and inflationary behavior that makes matters worse, perversely "resulting in an even larger bubble and a larger subsequent recession," warns John Makin, an economist at the American Enterprise Institute.

We've been there before. In the 1960s and 1970s, the Fed followed easy-credit policies on the belief—conceived and advocated by eminent economists—that government could end recessions and constantly keep the economy close to "full employment." The bad behavior thus encouraged was inflationary wage and price increases by firms and workers relieved of the fear of recession. The experiment boomeranged: double-digit inflation ensued along with the savage 1973–75 and 1981–82 recessions (peak unemployment: 9 percent, 10.8 percent). The real "moral hazard" problem today is not starting down that path again.

© 2007