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In 2022, there was widespread belief that the economy in 2023 would be a complete disaster. Last year, a Bloomberg economic model boldly claimed that the chances of a recession in the U.S. were certain – 100 percent, to be precise. Not 99.99 percent, like the odds of being struck by lightning tonight, but a solid guaranteed 100 percent, like avoiding time travel to have dinner with Louis XIV in 17th-century Versailles.
Bloomberg’s prediction was not an outlier. The Federal Reserve itself projected significant job losses by December. Economists surveyed by the Philadelphia Fed reached levels of pessimism not seen since the stagflation crisis of the 1970s, the severe recession of the 1980s, and the Great Recession of 2008. Even CEOs were bracing themselves for a recession, with a KPMG poll revealing that nine out of ten chief executives anticipated one in 2023. Adding to the narrative, Republicans eagerly blamed the White House for a supposedly inevitable “Cruel Biden Recession,” based on the expert consensus.
But here’s the twist – the experts got it all wrong. We are now halfway through a year that was supposedly doomed, and not only have we managed to avoid a downturn, but the U.S. economy is actually thriving. As writer Noah Smith points out, almost every aspect of an ideal economy is currently on track.
Employment rates are high, inflation is decreasing, real incomes are rising, and income inequality is narrowing. The official unemployment rate is near a historic low, and the jobless rate for Black Americans recently hit an all-time low. Compared to other G7 countries, the U.S. has the fastest growth rate and the lowest annual inflation. Of course, challenges remain, such as unaffordable housing, education, and healthcare, and wages could be growing faster. However, overall, things are looking good – for now.
To be fair, there were valid reasons for economists to expect a rough 2023. When inflation soared, the Federal Reserve responded by raising interest rates. Historically, this move often leads to a recession. The logic behind it is simple: higher interest rates increase the cost of capital, reduce investment, hinder hiring, slow down wage growth, affect consumer spending, and ultimately, cause an economic downturn that helps cool off prices.
But 2023 has not followed this familiar pattern at all. Instead, we seem to be experiencing a rare phenomenon called “immaculate disinflation” – falling inflation without rising unemployment. So, what went wrong with the experts’ predictions? How did we manage to tackle inflation without triggering a recession?
Firstly, economic prediction has always been more of an art than a science. Throughout history, the majority of economists have failed to anticipate recessions accurately. In fact, since the Philly Fed survey began in 1968, less than a third of economists correctly predicted the recessions of 1990, 2001, and 2008. Economic models are essentially a blend of astrology and calculus equations.
Secondly, the U.S. economy resiliently weathered several shocks, only to see them disappear eventually. J.P. Morgan’s Michael Cembalest likened this resilience to the survival skills of Rasputin, the Russian mystic who endured poisoning, beatings, and shootings. Similarly, the U.S. economy endured a series of challenges – a surge in post-pandemic spending, disruptions in supply chains, increased resignations in the service sector, energy price spikes, real estate inventory depletion, and global slowdowns. But like Rasputin, the economy survived. Eventually, the pain subsided, and the torturous inflation surprises dissipated.
Interestingly, this explanation leaves the Federal Reserve out of the equation. And perhaps that’s significant. Looking back over the past 15 years, it seems that monetary policy may not be as powerful as experts believed in stimulating or depressing economic growth. During the 2010s, the Obama administration relied heavily on the Fed and low interest rates to boost the sluggish economy. However, economic growth remained lackluster. If the Fed’s actions were insufficient to stimulate a demand-depressed economy previously and now can’t depress an overstimulated economy facing high inflation, maybe it’s time to reassess the importance of interest rates in overall economic health.
On the other hand, writer Matt Yglesias offers a different interpretation. He suggests that the Fed deserves more credit for its role. Central bankers aren’t just secluded wizards manipulating interest rates; they also shape expectations, moods, and vibes. The chair of the Federal Reserve wields immense influence over the U.S. economy. By combining the right statements and actions, they could maneuver the economy into the Goldilocks zone – just anxious enough to curb consumer spending and wage growth while other economic disruptions resolved themselves.
In fact, something strange has been going on for the past two years. Despite the economy performing well, ordinary Americans seem convinced that it’s disastrous. Negative views of the economy rose to record levels, even as unemployment reached historic lows. Jeff Bezos once famously said, “when the anecdotes and data disagree, the anecdotes are usually right.” Americans’ perception of the economy has been disconnected from reality. A significant portion believed that the country was in a recession, despite evidence to the contrary. This can be described as a “vibecession” or a phenomenon where people contribute positively to a growing economy while simultaneously expressing a vague anxiety about an impending collapse. It’s a peculiar situation where people feel depressed about the national economy but remain hopeful or even happy about their own household economy.
So, here’s an intriguing theory: maybe the recession forecasters were so convincing in their belief that an economic downturn was imminent that they inadvertently prevented it. The sense of economic uncertainty may have curbed spending, hiring, and wage growth, which in turn helped reduce inflation without pushing the economy into a full-blown recession. In a medical analogy, it’s akin to a weaker virus inoculating individuals against the actual virus. Fed Chair Jerome Powell and his team might have injected a dose of harmless gloom into the economic system, resulting in a favorable macroeconomic response that tackled inflation without triggering a downturn.
Or perhaps all these theories have some truth to them. Economic forecasting is akin to genre fiction, the U.S. economy defied expectations, the Fed’s carefully crafted pessimism had a marginal impact on inflation, and maybe it’s time to rethink the significance of interest rates in economic health.
As we continue to navigate the complexities of the economy, we must stay open to new ideas and theories. With each passing year, the economy reveals its unpredictability, challenging established beliefs and theories. The road ahead may bring more surprises, but by critically examining the past and present, we can better prepare for the future.
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