Bottom Line: While recessions are not formally defined for state economies, economic data for the fourth quarter of 2022 and first quarter of 2023 appear consistent with California experiencing a mild recession. The apparent start of a recession in California last fall helps explain why the state faced a revenue shortfall in its most recent budget. How much the economy will continue to dampen the state's fiscal picture moving forward is unclear. However, the threat that the recent slowdown could persist will be a significant risk for the foreseeable future.
Over the last year, there have been a number of signs that the state's economy may be slowing. State tax collections have weakened. Investment in young and growing technology firms has dried up. Housing market activity has dropped off. A number of regional banks have failed. And yet, the extent to which these factors are tied to a widespread slowdown of California's economy has been unclear.
Recent data, however, is beginning to paint a clearer picture about the nature of the recent slowdown in the state's economy. In particular, data on jobs, inflation-adjusted (real) incomes, real consumer spending, and the unemployment rate all point to a notable slowdown of the state's economy beginning around the fall of 2022.
Each dot represents California's growth rate for jobs and real incomes for a calendar quarter between 1980 and 2023. The 2022Q4 and 2023Q1 dots fall in the area of the graph representing weakness and are grouped with dots from past recessions.
The growth rate of California's real taxable sales also was weak in 2022Q4 and 2023Q1. (This measure of taxable sales excludes fuels and certain online sales.)
The state's unemployment rate, shown below, has climbed quickly since last summer, triggering the state version of a real-time recession indicator known as the Sahm Rule. The signal has accurately timed the beginning of the last six recessions.
Just how significant is California's recent economic slowdown? How similar is this slowdown to past recessions? While all recessions are different, historical recessions have shared some common characteristics. In particular, periods of several months or more during which employment, incomes, and consumer spending all declined historically have occurred only during recessions. As can be seen in the graphs above, the state appears to have entered such a period in the fall of 2022. While the timing of the slowdown varies across the measures, the fourth quarter of 2022 and first quarter of 2023 are marked by negative growth rates in all three areas. Adding to this, the state version of a commonly-used recession indicator triggered on in the first quarter of 2023. This indicator, known as the Sahm Rule, has historically triggered on between one quarter before and one quarter after the start of a recession.
The observation of a widespread slowdown of California's economy around the fall of 2022 offers some key insights. First, it offers an explanation for the recent slowdown in state tax collections. Despite some improvements in the last few months, tax collections have been and are anticipated to continue to be weak by historical standards. Second, the slowdown is suggestive of the importance of the technology and housing sectors to the vitality of the state's economy. Slumps in these areas could have been important contributors to more widespread slowdowns. Finally, California's slowdown raises questions about the national economy. Historically, recessionary conditions in California have always coincided with official U.S. recessions. Does this suggest California's slowdown could be a harbinger for the U.S. economy? Maybe. However, isolated state recessions are not unprecedented. For example, several energy-producing states experienced isolated downturns in 2015 and 2016 due to significant oil price declines.
If the state's economy entered a widespread slowdown last fall, where is it today? That remains unclear. Limited data are available for most of 2023. Data that are available, such as monthly jobs numbers, are preliminary and will be revised. Recently, those revisions have tended to pull down the preliminary figures. With incomplete data on the present state of the economy, we could look to the past as a possible guide. In past economic slowdowns, job growth has tended to take a while to rebound once it begins to deteriorate. That may not be the case this time, but there is a meaningful risk of repeating this historical pattern. As such, the threat that the recent slowdown could persist, or even deepen, will continue to be a significant risk to the state's fiscal picture for the foreseeable future.