Previously published on December 16, 2022 in
By Milton Ezrati, Chief Economist at Vested
‘Tis the season for articles that look back at the past year and forward to the next. For this look, it seems as though an extremely ambiguous and consequently frustrating 2022 will give way to a greater resolution in 2023.
Last year’s economy certainly created frustration. Take the path of inflation. It was severe and persistent enough to convince Washington to dispense with the 2021 nonsense that the price pressures were merely “transitory.” But a lingering and misplaced impulse to blame everything on Vladimir Putin kept alive an unrealistic hope that inflationary pressures would dissipate on their own.
The economy looked weak enough to raise widespread concerns of a recession but not so weak that policy postures changed, either in the White House or Congress. Federal Reserve policy, which started 2022 with an air of insouciance, then suddenly became harshly anti-inflationary in the middle of the year, ended 2022 with talk of moderation.
Without a doubt, the new year will carry its own frustrations and ambiguities. But—for good or ill—last year’s ambiguities should receive clarity. Here’s how each will likely play out over the next 12 months.
Inflation will remain persistent enough to at last erase the last vestiges of optimism—perhaps even enough to penetrate the White House. All the distracting talk of inflation being “transitory” or that price pressures will ease on their own accord will disappear. A consensus should form that matters require strong and consistent policy measures, especially from the Fed.
Actual inflation measures may fall short of the 9 percent 12-month price hike recorded for the consumer price index (CPI) last June—they already have—but rates of increase—probably in the 5 to 7 percent range—will persist and be widely recognized as unacceptable. They’ll certainly remain above the Fed’s inflation target of 2 percent. Even as monetary policy rises to the challenge, the danger is that inflation’s persistence will create expectations that it will continue—a state of affairs that could prolong the price pressure and blunt the effects of anti-inflationary monetary actions.
Federal Reserve Policy
Because of this inflationary reality, the Fed should continue to raise interest rates and restrict money flows that are the root cause of inflation. As interest rates rise to higher levels, policymakers should moderate the pace at which they increase them, less because they believe they’ve done enough but rather because, as Fed Chairman Jerome Powell recently explained, they’ll make allowances for the lagged effects of what they’ve already done.
However fast Fed policy moves, history makes clear that it can’t effectively blunt price pressures until interest rates rise to or above the ongoing inflation rate. With inflation in the 5 to 7 percent range, that’s considerably above where interest rates are now.
The economy couldn’t help but feel a recessionary effect from this type of monetary policy. Economic activity has already weakened appreciably. Some aspects of the economy continue to show strength, most notably consumer spending and hiring. But both are showing much smaller gains than six or 12 months ago.
Hiring could change abruptly since job creation tends to lag the pace of overall economic activity, both when it turns down and when it turns up. If the economy has already entered a recession, it will extend it into 2023 and become more definite. If it hasn’t yet entered a recession, it will likely do so in 2023. The good news is that the recessionary adjustment will likely run its course before the new year ends so that by the second half of 2023, clear signs of recovery will begin to emerge. This recovery’s strength will fall far short of the unprecedented pace that typified the rebound from COVID-19 lockdowns, but it will be a recovery, nonetheless.
Fiscal policy should remain unresponsive throughout. A standoff between the Republican-controlled House of Representatives and the Democratic-controlled White House will likely stymie any response to either recession or inflation. Such an impasse might lift if either problem goes to extremes, but nothing on the horizon suggests that extremes will develop. It may be just as well.
Should Washington act against inflation, and certainly if it acts against recession, the effect of such policies would almost certainly reach full force only after the economy has finished adjusting. They would consequently create more distortions than anything else.
This isn’t an especially exciting outlook, but neither is it frightening. It should be welcome because it will resolve some of the uncertainties of the past year, and a definite picture of economic conditions and prospects can offer a good groundwork for healing and recovery. Politics and geopolitics should remain as frustrating and impenetrable as ever.