By Mike Walden
The year 2024 began with optimism for the economy. Despite relatively high interest rates and efforts by the Federal Reserve to slow the pace of the economy in order to reduce the inflation rate, a recession was avoided. The hope for a “soft landing” in the economy, where price gains are moderated without pushing the economy into reverse, seemed to have been achieved. And hope increased that the Fed would begin reducing its key interest rate sometime during the year.
But a few weeks ago this optimism seemed to disappear. In one day the Dow-Jones stock average, one of the most followed measures of the stock market, dropped a headline-grabbing 1000 points. This drop followed a disappointing job market report and a jump in the unemployment rate. It was also reported that after the higher jobless rate was posted, one indicator of the future economy called the Sahm Rule was now predicting a recession.
Immediately I received numerous calls for my interpretation of what’s going on with the economy. In my answers I first gave background for the factors shaping the current economy. I then followed with a discussion of likely forecasts of where the economy will go. I will attempt to do the same here.
The Covid-19 pandemic and resulting recession prompted the federal government to “go big” with fiscal policy. Fiscal policy is the government using the tools of taxes and spending to impact the economy. The worry during the pandemic was that the economy wouldn’t recover and the jobless rate would linger in the double digits. As a result, during 2020, 2021 and part of 2022 the federal government pushed trillions of dollars into the economy in the form of program spending and financial support to households and businesses. At the same time, monetary policy, which is operated by the Fed, expanded the money supply by trillions of dollars and pushed interest rates to historic lows. In the second half of 2020, the economy began roaring back. By the end of 2020, the jobless rate had been cut in half, and the annual all-item inflation rate was at a low 1.3%. It looked like the economy was on to a strong, low inflation recovery.
But what was different from previous recoveries from a recession — and what policymakers didn’t anticipate — was global supply chain problems which kept a variety of products off the shelves. Hence, just when households were flush with cash — compliments of government financial assistance — and ready to spend, there was less available for them to buy. The shortages impacted everything from homes to paper towels to lumber. There was an enormous gap between the amount people wanted to buy (“demand” in economics lingo) and the amount available to sell (“supply” in economics-speak). The result was a sustained jump in prices, with the annual inflation rate reaching 9.1% in June 2022.
Although the Fed was late in anticipating the problem, by 2022 the Fed completely reversed its monetary policy and began raising interest rates and cutting the money supply in order to slow consumer spending and moderate price hikes. Also, at the same time the global supply was being fixed and shelves became full. The combination of less robust “demand” and greater “supply” allowed the annual inflation rate to drop to near 3%, still higher than in 2020, but certainly a sign of progress.
Topping these achievements is the fact that they’ve been accomplished without a recession, which is unusual. This brings us to today. Will the Fed continue to be able to claim the glory of cutting average price gains to a more normal 1% to 2% with no recession in the process?
For those inclined to answer “no,” there are three worries. Households have run through their COVID savings and will have to increasingly borrow to sustain spending. But this can’t last forever, so at some point consumers may reduce spending, thereby causing businesses to cut payrolls and employees.
Until very recently, investment markets have been booming. Since 2021, the stock market is up 25%, and average home prices have surged 33%. If deep cracks appear in the economy, investments like stocks and real estate could begin losing value, with the losses sparking trauma in the economy.
Last, while the Fed perceives these concerns and has signaled a readiness to begin reducing interest rates, the fear is the Fed may have waited too long. Pessimists think the damage has already been done and a recession is already baked into the cake.
And although the optimistic camp doesn’t expect a recession, it recognizes these three worries. Optimists agree consumer spending and the labor market are slowing, investment markets may give back some of their gains, and the Fed has been slow to cut rates and increase the money supply. But while the pessimists see these conditions leading to recession, the optimists see them resulting in a slowdown. Indeed, optimists point out that the recent increase in the jobless rate wasn’t due to job losses, but instead happened because the number of jobs created was less than the number of new people looking for jobs. So optimists expect the economy to continue to grow, just at a slower pace. Optimists see a slowdown, not a meltdown, in the economy.
Let me throw in my two cents worth about North Carolina’s economic future. Each month I construct a leading economic index for the North Carolina economy. The index has been relatively stable for the past year, suggesting a path of continued growth in the state.
At the beginning of 2024 I forecasted a bumpy national economy for the year. By bumpy I meant some pullback in growth and investments, as well as some months where the jobless rate would rise, but no sustained period where the important elements of the economy all declined. Hence, the choice for the remainder of 2024 appears to be between negative growth and a recession, or slower growth — which can result in higher joblessness — but no recession. Which makes the most sense? You decide.
Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.
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