Federal Reserve Chairman Jerome Powell now recognizes it will be difficult to avoid a recession, but accomplishing this soft landing will depend on accepting a higher inflation target than 2%.
The Fed began raising the federal funds rate in March, but mortgage rates began moving up in January. Contracts to purchase existing homes began tailing off in January, home sales followed in February, and ultimately lumber prices, a bellwether for building materials, declined.
The pandemic depressed new home construction. Consequently, the stock of available housing—both owner-occupied and rentals—will remain tight.
High-quality housing price data, like the S&P Case-Shiller index, are published with a considerable lag. We are likely to see some moderation from 20% annual increases in sale prices but hardly an end to significant housing inflation.
Healthy job growth
More broadly, ordinary Americans are worried about a recession, but businesses continue to add employees at a decent pace and more adults are re-entering the labor force. According to the Atlanta Fed, wage increases have accelerated to 6% annually.
Facing labor shortages, businesses are installing more robots, and productivity growth should recover. That will permit businesses to pay those higher wages while keeping labor-induced price increases modest.
Strong consumer demand will likely continue to outstrip supply, creating other inflationary pressures. Part of this is sectoral shifts in consumer demand that aggregate data and macroeconomic models and forecasts generally miss, and another part is international factors and policy decisions of the Biden administration.
Households are saving
Households are saving less to cope with rising gas
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and grocery prices and broader general inflation, but they are still adding to their balance sheets—$815 billion annualized in May.
Thanks to banked stimulus checks and other pandemic aid, households and nonprofits have more than $3 trillion in checking and savings deposits that they did not have before COVID.
Granted, this cushion is not evenly spread. Working families getting along below the median household average income feel higher gas and grocery prices more acutely.
Mass retailers such as Walmart
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and consumer-goods companies such as Procter & Gamble
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are getting push back on prices but luxury retailers, who benefit from high-income patrons’ huge cash hoards, are taking big prices increases.
Overall, there’s going to be a lot of pain and gain that aggregate data don’t capture, but it’s far from certain that the Fed raising rates or running down its balance sheet will dent aggregate consumer spending enough to throw the economy into a deep recession.
More likely, unemployment will creep up as the Fed predicts to something just above 4%.
Supply-side problems
As this column previously argued, the longer-term problems are on the supply side of the global economy and inflation should settle at least or above 4%.
The war in Ukraine is grinding to a stalemate, but it is important to remember that food and energy prices tend to overcompensate in the short-run.
Russian President Vladimir Putin can only cut off Ukrainian grain
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and oilseed exports through the Black Sea once. Finding other ways to export this year’s grain is expensive and incomplete, but over time things should loosen up and other sources of supply can be developed.
U.S. and European sanctions and phase out policies for Russian petroleum spiked prices, but markets will replumb and considerably more Russian oil and gas will be sold in Asia.
Europeans will tap other sources, but Biden administration policies discouraging investment in the U.S. petroleum sector limit those options.
Wrapping it all together, without a deep recession, food and energy prices
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should continue to rise in 2023, but the pace should be more moderate.
How high will the Fed go?
The real questions become: How critical are the first round of interest rate increases? Does the Fed stick to its 2% target as inflation slows but remains stubbornly above that level?
If the Fed raises the federal funds rate by another half or three-quarter points in July and then more moderately at subsequent meetings, that key policy rate would still be below the likely pace of wage and price inflation.
If car sales lag, it will be because of the continued shortage of chips, and home buyers will eventually recognize that mortgage rates are not as onerous viewed against prospective long-term inflation and wage growth.
In 2023, the Fed will be looking past the midterm elections to Donald Trump running again and perhaps recapturing the White House. As Powell surely remembers Trump’s badgering, he may be reluctant to push the economy into a deep recession to get inflation down to 2%.
Paul Volcker only got inflation down to about 4%.
Next winter, Chairman Powell may well declare victory with inflation headed down to 4% and take his foot off the brakes.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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