The recession America was expecting never came.
Many economists predicted a painful recession as early as 2023, a view so widely believed that some commentators began treat it As given, Inflation had reached its highest level in decades, and many forecasters thought this would lead to a decline in demand and quantum leap in unemployment To wrestle it down.
Instead, the economy grew 3.1 percent last year, down from less than 1 percent in 2022 and faster than the five-year average before the pandemic. Inflation has reduced to a great extent. Unemployment remains at historic lows and consumers are continuing to spend despite Federal Reserve interest rates hitting a 22-year high.
The divide between doomsday predictions and heyday reality is forcing Wall Street and academia to consider. Why do economists make so many mistakes, and what can policymakers learn from those mistakes as they try to predict what might happen next?
It is still early days to draw concrete conclusions. The economy could still slow as the Fed begins to add up to two years of rate hikes. But what is clear is that old models of the relationship between growth and inflation do not serve as accurate guides. Bad luck drove the initial burst of inflation more than some economists appreciated. Good luck helped narrow it down again, and there were other surprises along the way.
“It’s not like we fully understood the macro economy before, and it was a very unique time,” said Jason Furman, a Harvard economist and former economic official in the Obama administration, who thought it would be better to reduce inflation. This will require high unemployment. “Economists could learn a big, healthy dose of humility.”
Of course, economists have a long history of getting their predictions wrong. Very few people saw the global financial crisis at the beginning of this century, even once the mortgage crisis that gave rise to it was well under way.
Still, recent mistakes were particularly big. At first, many economists dismissed the possibility of rapid inflation. When prices soared, Fed economist and professional forecasters widely expected At least a brief period of contraction and an increase in unemployment. At least so far, neither has materialized.
“It was always difficult to predict what an economy would look like emerging from an unprecedented pandemic,” said Matthew Luzzetti, chief economist at Deutsche Bank, whose team’s recession forecast last year proved too pessimistic.
Not all economists expected a recession last year. Some had correctly expected inflation to decline as pandemic disruptions eased. But most of them were surprised by how little damage the Fed’s rate hike campaign has done.
Princeton economist Alan S. “The unemployment rate has not gone up since the Fed started tightening,” Blinder said. , “I don’t know how many people expected this. I know I didn’t do it.”
The trend of forecast errors began in early 2021.
Subsequently, some leading economists, including former Treasury Secretary Lawrence H. Summers of Harvard, began warning that the US could experience a surge in inflation as the newly elected Biden administration implemented a large stimulus package – including one-time checks and State and local aid — on top of the previous Trump administration’s coronavirus relief. They were worried that this money would increase demand so much that it would drive up prices.
Many government officials and economists loudly doubted that inflation would rise, but prices soared. Some of this was about demand, and some was due to bad luck and pandemic-related disruptions.
Pandemic-related stimulus money and lifestyle changes had helped boost purchases of goods at a time when the supply chains established to deliver those products were under pressure. Ocean shipping routes were not prepared to handle the flood of demand for sofas and gym equipment. At the same time, manufacturers faced rolling closures amid the virus outbreak.
Russia’s 2022 invasion of Ukraine further fueled the price surge by disrupting global food and fuel supplies.
By that summer, the US consumer price index had reached 9.1 percent annual growth and the Fed began to respond in a way that made economists think a recession was imminent.
Fed policymakers launched a rapid series of rate hikes in March 2022. The goal was to make it too expensive to buy a home or car or expand a business, which would slow the economy, hurt consumer demand and force companies to stop raising prices so high.
Such dramatic rate adjustments meant to reduce inflation typically precipitate recessions, so forecasters began predicting recessions.
“History has shown that these two things combined generally end up in a recession,” US Bank chief economist Beth Ann Bovino said, referring to the combination of higher inflation and rate increases.
But the economy — though challenging for some families amid high prices and expensive mortgages — never fell off that cliff. Hiring gradually slowed down. Consumer spending declined, but systematically and never dramatically. Even the interest-rate-sensitive housing market settled down without tanking.
Strong government support helps explain some of the resilience. Households were flush with savings they had accumulated during the pandemic, and state and local officials were slowly spending their government’s pandemic money.
Also, a strong job market helped raise wages, allowing many families to cope with price increases without having to cut back much. Years of extremely low interest rates have also given households and businesses the opportunity to refinance their loans, making them less vulnerable to the Fed’s actions.
And part of the continued strength was due to the fact that with inflation low, Fed officials could step back before they crushed the economy. They halted rate hikes after July 2023, keeping them in the range of 5.25 to 5.5 percent.
This raises a question: Why has inflation slowed even after the Fed stopped tanking growth?
Many economists had previously thought that a more pronounced recession was likely to be necessary to completely stop rapid inflation. For example, Mr. Summers, it was predicted With unemployment above 5 percent, it will take years to bring price rises under control.
“My view was that the soft landing” was “a triumph of hope over experience,” Mr. Summers said. “This seems to be a case where hope has triumphed over experience.”
He pointed to several factors behind the surprise: Among them, supply problems have eased more than he expected.
A large part of the deflation came from a reversal of previous bad luck. Gas prices declined in 2023, and those soft prices spread to other industries. Supply chain improvements have kept good prices from climbing and, in some cases, falling so rapidly.
And some economic cooling occurred. Although unemployment remained largely stable, the labor market rebalanced in other ways: there were About two job vacancies For every available employee in 2022. This has now declined to 1.4, and wage growth has slowed as employers compete less to hire.
But that labor market adjustment was softer than many expected. chief economist had suspected It would be possible to calm the conditions by cutting job opportunities without increasing unemployment.
“I would have thought it was an iron law that deflation is painful,” said Johns Hopkins economist Lawrence M. Ball, author of a book on deflation. impressive 2022 paper It was argued that reducing inflation would probably require increasing unemployment. “The broader lesson, which we never fully learn, is that things are very hard to predict and we should not be too confident, and especially when there is a very strange, historic event like Covid “
The question now is what this means for the coming months. Could economists be caught wrong again? He expects softening inflation, sustained growth and multiple Fed rate cuts this year.
“We have descended softly; We just need to get to the gate,” Mr. Furman said.
Fed officials are expected to outline their thinking at their meeting next week, which ends on January 31. Investors expect policymakers to keep interest rates steady, but they will watch a news conference with Fed Chairman Jerome H. Powell for any signs. Future.