Until quite recently there was a near consensus among forecasters that the U.S. economy was headed for a recession. In fact, it’s been exactly one year since Bloomberg declared that, according to its models, the probability of a recession by October 2023 — that is, now — was 100 percent.
OK, it’s possible — barely — that a recession has begun but isn’t in the data yet. Economists of a certain age remember that for much of 2008 some commentators denied that there was a recession underway, but the official business cycle chronology now says that the worst slump since the 1930s began in December 2007. That said, warning indicators like the Sahm rule, which looks at the unemployment rate compared with its previous low, were flashing red by the summer of 2008, in a way they aren’t now:
And forecasters, most of whom were very gloomy at the beginning of this year, have been backing off, with slightly fewer than half in a recent survey still predicting recession. My visceral reaction on seeing that headline was to say “Uh-oh” — given the track record of economic prediction, an optimistic consensus may be a reason to worry — but the truth is that the case for a soft landing, which I debated with Peter Coy a few weeks ago, keeps getting stronger.
The most important reason for optimism is that an ever-widening range of indicators suggest that the conventional wisdom — that we needed a recession to bring inflation under control — was wrong. Instead, we seem close to returning to the Federal Reserve’s inflation target without paying much of a price at all.
To see what I mean, here’s the Fed’s normal measure of underlying inflation, the “core” personal consumption expenditures deflator (try saying that six times fast) — that is, excluding volatile food and energy prices — measured over the past three and six months:
And since the traditional core inflation measure has seemed inadequate in the highly disrupted post-Covid world, here’s a more elaborate statistical measure from the New York Fed:
These measures suggest that underlying inflation is already most of the way back to the Fed’s target of 2 percent, and falling fast. The war on inflation looks almost over, and we won.
Now, if you say that, you get some hysterical pushback, much of it politically motivated: A key part of the Republican case against President Biden is the claim that he is responsible for runaway inflation, and partisans aren’t willing to let go of that argument. I’ve had some, well, interesting correspondence lately — for example, emails saying that by highlighting data suggesting that the inflation surge is over I’m a worse propagandist than Joseph Goebbels. Whatever.
Anyway, to the extent that there’s a real argument here, it involves the widespread use by economists of measures that attempt to extract underlying trends from the noise. Never mind these fancy numbers, say the critics; the prices real people actually pay are still soaring.
The truth, however, is nearly the opposite. At this point, U.S. inflation as measured by the Consumer Price Index is largely driven by prices people don’t pay — owners’ equivalent rent, an “imputed” estimate of what homeowners would be paying if they were renting their houses. An alternative measure, the Harmonized Index of Consumer Prices, which doesn’t include this imputation, shows inflation roughly down to target:
There are many other indicators suggesting that inflation is quickly coming under control. Wage growth is slowing rapidly, reducing fears of a wage-price spiral:
And business expectations of future inflation, which are a much better predictor than consumer expectations, are also way down:
One final point about the inflation news: Earlier this year, many economists, while acknowledging that inflation was falling without any visible cost in higher unemployment, insisted that the last mile — getting inflation from, say, 3 percent to 2 percent — would be much harder. But underlying inflation has by many measures already covered much of that last mile, without the predicted pain.
So fears that we needed a recession to control inflation seem increasingly unfounded.
The question now is whether we’ll get a recession anyway.
The big reason for concern is the fact that the interest rates we think matter most for the real economy have soared since the Fed began hiking to fight inflation:
If you had told me two years ago that interest rates would soar like this, I would have predicted a nasty recession with spiking unemployment. But in fact job growth, and probably G.D.P. growth, have just kept chugging along.
The problem for economic analysts is that there are two possible reasons the recession dog hasn’t barked. One is that we’re seeing fundamental economic change — that new investment opportunities have increased r-star, so that the economy can handle high interest rates indefinitely. The other is that there are, as Milton Friedman claimed, “long and variable lags” in the effects of monetary policy, and high rates will eventually break something major.
Which story is right? Honestly, I have no idea. My inbox is full of analysts inspecting the entrails of business data, seeking omens for the near-term future. Some of them may know what they’re doing, but which ones?
What I think we can say is that because a recession, if it happens, will be a stumble rather than something we actually need, that recession probably won’t be either deep or long.
For the economic news this year has been remarkably good, although many people refuse to believe it.
“Projections are increasingly consistent with a soft landing scenario, bringing inflation down without a major downturn in activity.”
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