Economists spent 2021 hoping that inflation would prove “transitory.” They spent much of 2022 underestimating his staying power. And they spent early 2023 predicting that the Federal Reserve’s rate hikes, intended to cure inflation, would plunge the economy into a recession.
None of those forecasts have come true.
Rapid inflation has been a reality for 30 consecutive months. The Federal Reserve has raised rates above 5.25 percent to curb price increases, but the economy has remained surprisingly strong in the face of those measures. Americans are working in greater numbers than anticipated, and recent retail sales data showed that consumers are still spending at a faster pace than anyone expected. For now, no economic recession is in sight.
The question is why experts misjudged the pandemic and post-pandemic economy so badly, and what this means for future policies and prospects.
Economists generally expect growth to slow later this year and early next year, raising unemployment and gradually weighing on inflation. But several said it had been so difficult to predict the economy since the pandemic that they had little confidence in future projections.
“Forecasts have been embarrassingly wrong across 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 too optimistic about inflation.
Two big issues have made forecasts difficult since 2020. 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 anticipate how it would affect commerce and consumer behavior.
The second complication came from fiscal policy. The Trump and Biden administrations invested 4.6 billion dollars of recovery money and stimulus to the economy in response to the pandemic. President Biden then pushed Congress to pass several laws that provided funding to encourage infrastructure investment and clean energy development.
Between coronavirus lockdowns and the massive government response, standard economic relationships stopped serving as good guides for the future.
Take inflation as an example. Economic models suggested it would not take off in a lasting way while unemployment was high. It made sense: If a group of consumers were out of work or making tepid wage gains, they would push back if companies charged more.
But those models didn’t account for the savings Americans had accumulated thanks to pandemic aid and months at home. Price increases began to take off in March 2021 as voracious demand for products like used cars and home exercise equipment collided with global supply shortages. Unemployment was above 6 percent, but that didn’t stop buyers.
The Russian invasion of Ukraine in February 2022 exacerbated the situation. driving up oil prices. And before long, the job market had recovered and wages were growing rapidly.
They were too pessimistic about growth.
As inflation demonstrated staying power, government officials The Fed began raising interest rates. to cool demand, and economists began predicting that the measures would plunge the economy into a recession.
Central bankers were raising rates at a speed not seen since the 1980s, making it considerably more expensive to get a mortgage or car loan. The Federal Reserve has never changed rates so abruptly without triggering a recession, many forecasters pointed out.
“I think it’s been very attractive to make forecasts based on these kinds of observations,” said Jan Hatzius, chief economist at Goldman Sachs, who has been predicting a milder cooling. “I think that understates how different this cycle has been.”
Not only has the recession failed to materialize so far, but growth has been surprisingly rapid. Consumers have continued to shell out money for everything from Taylor Swift Tickets to the dog daycare. Economists have periodically predicted that American shoppers near a breaking pointjust to prove him wrong.
Part of the problem is the lack of good real-time data on consumer savings, said Karen Dynan, a Harvard economist.
“We’ve been telling ourselves for months that people at the bottom of the income distribution have spent their savings,” he said. “But we really don’t know.”
At the same time, fiscal stimulus has had more staying power than expected: State and local governments continue to dole out money they were allocated months or years ago.
And consumers are getting more and better jobs, so income is driving demand.
Economists now wonder whether inflation can slow enough without a pullback in growth. Such a painless landing would be historically abnormal, but inflation has already cooled to 3.7 percent in Septemberdown from a maximum of about 9 percent.
Normality may still be a long way off.
Still, that’s too fast for comfort: Inflation was around 2 percent before the pandemic. Given the stubbornness of inflation and the staying power of the economy, interest rates may need to stay elevated to get it completely under control. On Wall Street, that even has a slogan: “Higher, Longer.”
Some economists even think that the world of low rates and low inflation that prevailed from roughly 2009 to 2020 may never return. Donald Kohn, former vice chairman of the Federal Reserve, said large government deficits and the transition to green energy could keep growth and rates higher by propping up demand for borrowed cash.
“My guess is things aren’t going to go back,” Kohn said. “But my God, this is a distribution of results.”
Neil Dutta, an economist at Renaissance Macro, noted that the United States had a baby boom in the 1980s and early 1990s. These people are now getting married, buying houses, and having children. Its consumption could underpin growth and borrowing costs.
“For me, it’s like the old normal: what was abnormal was that period,” Dutta said.
Federal Reserve officials, for their part, they are still predicting a return to an economy that looks like that of 2019. They expect rates to return to 2.5 percent in the long term. They think inflation will fade and growth will cool next year.
The question is what happens if they are wrong? The economy could slow more than expected as cumulative rate moves finally take effect. Or inflation could stagnate, forcing the Federal Reserve to contemplate higher interest rates than anyone has bet on. Not a single person in a Bloomberg survey of nearly 60 economists expects interest rates to be higher at the end of 2024 than at the end of this year.
Slok said it was a moment of modesty.
“I don’t think we’ve figured it out,” he said.