Is California’s economy heading for a recession?

California’s economy exploded as the state emerged from a relatively brief but severe recession caused by business closures ordered by Gov. Gavin Newsom in 2020 to combat the COVID-19 pandemic.

Almost overnight, more than 2 million Californians lost their jobs and the state’s unemployment rate skyrocketed to over 16%. However, as restrictions eased, the unemployment rate slowly dropped to pre-pandemic levels, below 4%, and California employers found it increasingly difficult to fill their jobs.

The state’s ride on a dizzying economic roller coaster may not be over yet.

Inflation is reaching rates of more than 8% not seen in decades, largely as massive federal spending aimed at countering the economic impact of the pandemic has overheated the economy and disrupted the supply-demand balance.

The Federal Reserve System is rapidly raising interest rates in hopes of cooling the economy, but its “soft landing” hopes are very uncertain and there are growing fears of a recession. In a way, it becomes a self-fulfilling prophecy as employers limit hiring in anticipation of a recession and these actions trigger a decline.

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As the country’s largest state, California is particularly exposed to national and global economic trends. When the US economy catches a cold, California often catches pneumonia.

Legislative budget analyst Gabe Petek warned of the state’s vulnerability last May while reviewing Gov. Gavin Newsom’s revised budget.

“It’s almost impossible to predict exactly when the next recession will hit,” Petek told the Legislature. “However, in the past certain economic indicators have given warning signs that a recession is on the horizon (and) many of these indicators are currently pointing to an increased risk of a recession within two years.”

Citing inflation, a national slowdown in economic output, declining home sales, and other factors, Petek noted that “a similar cluster of economic conditions has occurred six times in the last five decades. Each of these six recessions has occurred within two years (and often earlier).”

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However, Newsom’s budget assumed the state’s economy would continue to expand and generate billions in taxpayer dollars. Newsom boasted a nearly $100 billion surplus, and he and the Legislature vigorously found ways to spend it.

In the three months since the $308 billion budget was passed, signs of a slowdown — or perhaps the onset of a recession — have multiplied. Inflation rages on, the Federal Reserve continues to raise interest rates, the once-hot housing market has cooled, the stock market has taken a hit and California tax revenues have fallen billions of dollars short of the budget’s rosy projections.

This month, Petek released an updated and somewhat pessimistic review of the state’s economy and the likelihood of a revenue shortfall.

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“At the time of our May Outlook, we warned that economic indicators were suggesting a slowdown could be on the horizon,” Petek reminded lawmakers. “Recent economic data continues to point in that direction. Consistent with this, our updated estimates suggest that revenue from the state’s “big three” taxes – personal income, sales and corporate income taxes – is more likely to fall below the Budget Act assumption of $210 billion.”

After the budget passed, the Legislature sent Newsom dozens of bills that, if signed, would add up to $30 billion in new spending. Citing that estimate, the governor has vetoed spending bills with this warning: “As our state faces lower-than-anticipated revenues in the early months of this fiscal year, it’s important to remain disciplined on spending.”

That’s a remarkable change in tone in just a few months.

Dan Walters is a columnist at CalMatters.