Economists spent 2021 expecting inflation to prove “temporary”. He spent most of 2022 underestimating its staying power. And he spent early 2023 predicting that the Federal Reserve’s rate hikes to tame inflation would send the economy into recession.
None of those predictions came to fruition.
Hyperinflation has now become a fact of life for 30 consecutive months. The Fed lifted rates above 5.25 percent to stem price rises, but despite those steps the economy remains surprisingly strong. Americans are working in greater numbers than anticipated, and recent retail sales data showed that consumers are still spending faster than anyone expected. At present there is no possibility of economic recession.
The question is why experts misjudged the pandemic and post-pandemic economy so seriously – and what this means for policy and the future outlook.
Economists generally expect growth to slow late this year and early next year, causing unemployment to rise and inflation to gradually ease. But many said the economy has become so difficult to predict since the pandemic hit that they have less confidence in future projections.
“Forecasts have been embarrassingly wrong throughout the forecasting community,” said Torsten Slok of asset manager Apollo Global Management. “We’re still trying to figure out how this new economy works.”
Economists were very optimistic about inflation.
Two major issues since 2020 have made predictions difficult. The first was the coronavirus pandemic. The world had not experienced such a widespread disease since the Spanish Flu in 1918, and it was difficult to predict how it would affect commerce and consumer behavior.
The second complication came from fiscal policy. Trump and Biden administration $4.6 trillion added Recovery and stimulus of funds to the economy in response to the pandemic. President Biden then pressured Congress to approve several pieces of legislation that would provide funding to encourage infrastructure investment and clean energy development.
Amid the coronavirus lockdown and the government’s heavy-handed response, standard economic ties stopped serving as a good guide to the future.
Take inflation. Economic models suggested that unemployment would not grow sustainably as long as it remained high. It made sense: If a group of consumers were out of work or earning low wage benefits, they would step back if companies charged more.
But those models did not take into account the savings that Americans accrued from pandemic aid and staying at home for months. Prices began rising in March 2021 as strong demand for products such as used cars and home exercise equipment was offset by a global supply shortage. Unemployment was above 6 percent, but that didn’t stop shopping.
Russia’s invasion of Ukraine in February 2022 worsened the situation, causing oil prices to rise. And soon, the labor market had recovered and wages were rising rapidly.
He was very pessimistic about development.
As inflation appeared to be stagnating, Fed officials began raising interest rates to stimulate demand – and economists began predicting that these steps would send the economy into recession.
Central bankers were raising rates at a pace not seen since the 1980s, making it increasingly expensive to get a mortgage or car loan. Many forecasters said the Fed had never changed rates so suddenly without precipitating a recession.
“I think it’s very tempting to make forecasts based on these types of observations,” said Jan Hatzius, chief economist at Goldman Sachs, who is predicting a milder situation. “I think that shows how different this cycle is.”
Not only has a recession failed to materialize so far, but growth has also been surprisingly rapid. Consumers continue to spend money on everything from Taylor Swift tickets to dog day care. Economists have routinely predicted that U.S. shoppers are headed for a recession, but they have been proven wrong.
Part of the problem is the lack of good real-time data on consumer savings, said Harvard economist Karen Dynan.
“It’s been months now that we’ve been telling ourselves that people at the bottom of the income distribution have spent their savings,” he said. “But we don’t really know.”
At the same time, fiscal stimulus has had longer staying power than expected: State and local governments continue to distribute funds allocated months or years in advance.
And consumers are getting more and better jobs, so income is driving up demand.
Economists are now asking whether inflation can slow sufficiently without causing a decline in growth. Such a painless landing would be historically unusual, but inflation has already declined to 3.7 percent from a high of nearly 9 percent in September.
Normal may still be away.
Still, it’s too early for comfort: Inflation was around 2 percent before the pandemic. Given the stubbornness of inflation and the stability of the economy, interest rates may need to be kept higher to bring it completely under control. On Wall Street, it even has a tagline: “Higher for a Longer.”
Some economists even think that the low-rate, low-inflation world of 2009 to 2020 may never return. Former Fed Vice Chairman Donald Cohn said larger government deficits and a transition to green energy could keep growth and rates high by boosting demand for borrowed cash.
“My guess is things are not going to go back,” Mr. Cohn said. “But oh my God, it’s the delivery of results.”
Renaissance Macron economist Neil Dutta said that America there was a baby boom In the late 1980s and early 1990s. Those people are now getting married, buying houses and having children. Their consumption may increase development and borrowing costs.
“For me, it is like the old normal – what was unusual was the period,” Mr Dutta said.
Fed officials, for their part, still predicting Back to an economy that looks like 2019. He expects rates to return to 2.5 percent in the longer term. They think inflation will subside next year and growth will slow.
The question is, what if they are wrong? The economy could slow down faster than expected as accumulated rate fluctuations eventually dissipate. Or inflation could get stuck, forcing the Fed to consider raising interest rates heavier than any gamble. Not a single one in a Bloomberg survey of nearly 60 economists expects interest rates to be higher at the end of 2024 than they were at the end of this year.
Mr Slok said it was a humbling moment.
“I think we haven’t figured it out,” he said.