What recession? Inflation and GDP give hope for a soft landing

Perhaps a recession in 2023 can still be avoided.

The persistent fall in prices, along with a stronger-than-expected fourth-quarter gross domestic product (GDP) and a less aggressive Fed interest rate hike expected next week, are changing the mood of economists and resurrecting hopes for the overall health of the economy.

The Personal Consumption Price Index (PCE) fell to 5% year-on-year last month from 5.5% in November, Commerce Department data showed on Friday, reflecting a drop in the consumer price index (CPI) from 7.1% to 6. 5% for the same period. The consumer price index has fallen every month since June, when it peaked at 9.1 percent a year.

Data released yesterday showed that the US economy grew faster than expected by 2.9% in the last three months of the year, down slightly from 3.2% in the third quarter, but strong enough to lead to an annual growth of 2.1%. %. percent. GDP contracted in the first and second quarters of 2022 after a huge recovery in 2021.

U.S. production levels are now largely in line with pre-pandemic levels using seasonally adjusted measurements and inflation adjustments.

The positive numbers have led some economists to chide market commentators for an overly pessimistic performance of the economy during 2022, a year in which many Americans believed a recession had already begun.

“Worst. Recession. Never,” University of Michigan economist Justin Wolfers joked online after the GDP data was released.

“There is a lot to be said about these latest GDP figures, but I think they underscore what they have now made official: there was no recession in 2022. Wolfers added.

Harvard Kennedy School economist Jeffrey Frankel, a former member of the National Bureau of Economic Research committee that officially defines recessions, told The Hill that he’s still hearing opinions about the prospect of a recession this year, but he doesn’t think it’s accurate. .

“Many economists have gone too far in saying that a recession in 2023 is almost inevitable. I would put the chance of a recession this year at about 35 percent,” Frankel said in an email to The Hill.

The US’s rapid recovery, along with a rapid fall in consumer prices, is leading some observers to reconsider the characterization of inflation as “transitory”—a notion that was dismissed by economists in the summer when annual price increases topped 9 percent, leading even Secretary Janet Yellen to say she was wrong. about inflation and did not fully understand what caused it.

“At this point, the burden of proof is on anyone who claims we had more than a temporary spike in inflation that is largely behind us,” New York Times economics columnist Paul Krugman wrote last week.

Former Federal Reserve banker Claudia Sam said the same thing in December, writing that “the burden of proof is now on the inflation hawks.”

“With a constant stream of more optimistic inflation data and the path to a soft landing, it is time for the hawks to explain themselves,” she wrote in the weekly newsletter. “Reality shows that a soft landing in 2023 in the United States is taking shape. We avoid a recession, keep a full recovery, and inflation is down again. Hawks, it’s time to join us in reality.

University of Massachusetts economist Arin Dube pointed the finger at “public economists” for failing to accurately capture the power of the economic recovery from the coronavirus pandemic.

“It’s not just about the politicians and the press,” Dube wrote on the Internet Thursday. “Too many public economists downplay the recovery over the last two years.”

Perhaps the most vocal of these economists was former Treasury Secretary Larry Summers, who has argued time and time again that inflation is a far more permanent problem than the Fed has imagined, and that it will take years of high unemployment to correct the situation. .

During a speech in London last year, Summers said the economy needed five years of unemployment above 5 percent to properly contain inflation.

“In other words, we need two years of unemployment at 7.5%, or five years of unemployment at 6%, or one year of unemployment at 10%,” he said.

In fact, inflation was declining even as unemployment remained at a roughly 50-year low of 3.5 percent, suggesting that price spikes during the pandemic are due less to the labor market than to other factors, including shocks. proposals and trends towards profit maximization among firms. .

The reason many of these estimates are wrong is because of outdated modeling and economic thinking, according to Westwood Capital investor and founder Dan Alpert.

“People whose scientific careers and careers in business forecasting are based on economic modeling and macroeconomics, which grew out of fundamental microeconomics over 30 years, say from the late 1970s to the end of the century, they have invested heavily in the way they look at the world, associated with … the impact of labor on prices, ”Alpert said in an interview with The Hill.

“But these models don’t really apply to a fully fiat world where you really don’t have currency restrictions and you have credit developing through multiple channels and you have huge asset inflation without having a lot of goods and services and wages. fees. inflation,” he said.

But even with all the positive data, there are some potential signs that the US economy could slow down.

Friday’s PCE data showed a 0.2% drop in consumer spending in December, more than November’s 0.1% drop. The fall in spending affected mainly the goods sector.

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The Philadelphia Federal Reserve expects more sluggish growth in 2023 at 0.7 percent for the year as the Fed continues its monetary tightening program.

“Excessive tightening of monetary policy will lead to an unnecessarily sharp slowdown in the global economy, which could be avoided,” UN economists warned in the World Economic Situation and Prospects report released on Wednesday.

“While it is too early to determine whether central banks have tightened their monetary policy too much in developed countries, in particular in the US and Europe, this risk should not be ignored. Still fresh in memory is the “cut tantrum” in 2013, when the Federal Reserve’s announcement to cut back on bond purchases immediately led to a sharp increase in government bond yields. The sell-off in Treasuries spilled over into corporate bond markets and disrupted equity markets,” they wrote.

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