Almost a year has passed since the Bureau of Economic Analysis, which estimates the gross domestic product, announced that real GDP has declined over the previous two quarters – a phenomenon that is widely, albeit incorrectly, described as the official definition of a recession.
Right-wingers had a field day, shouting about the “Biden recession”. But it wasn’t just a party thing. Even forecasters who knew that recessions are defined by multiple indicators, and that the United States was not yet in a recession, began to predict one in the near future. As Mark Zandi of Moody’s Analytics, one of the few prominent recession skeptics, put it: “Every person on TV says recession. Every economist says recession. I have never seen anything like it.”
By late 2022, members of the Federal Reserve Committee that sets monetary policy were prediction an unemployment rate of 4.6 percent by late 2023; private forecasters predicted 4.4 percent. Either of these forecasts would have implied at least a mild recession.
To be fair, we don’t know for sure that these predictions will be falsified. But with unemployment in June only 3.6 percentJust as it was a year ago, and job growth is still surging, the economy would have to fall off a steep cliff very soon to adjust them, and there is little hint in the data of that happening.
So it sure looks like economists made a bad recession call. Why were they wrong?
One answer might be to ask why anyone would expect them to get it right. A few years ago the International Monetary Fund did a a systematic study of the ability of economists to call recessions in advance, and essentially found that they never succeed. As the authors noted wryly, there was little to choose between private and official forecasts: “Both are equally good at missing recessions.”
In some ways, however, the IMF study is not so relevant to what we have just seen. The authors found many examples of recessions that occurred but that prognosticators did not predict; what we are seeing now is a recession that forecasters predicted but failed to achieve. So where did this almost unanimous but, as it turns out, unwarranted pessimism come from?
I know that at least some forecasters looked at a certain financial indicator: the spread between short-term and long-term bonds. An inverted yield curve, in which long-term bonds pay a lower interest rate than short-term bonds, has historically predicted recessions, as is evident if you note the years in which this occurred in the following chart:
But the meaning of an inverted yield curve is widely misunderstood. It doesn’t cause recession It is instead an implicit prediction about future Fed policy — namely, that the Fed will cut rates sharply in the future, presumably to combat a deepening recession. So the inverted yield curve wasn’t really an independent indicator, just a market reflection of the same “recession is coming” consensus you heard on cable TV.
So where did that consensus come from? Leaving aside all the necessary “Biden’s socialism will tank the economy,” I think it’s fair to say that most economists thought we were seeing a repeat of the early 1980s. What happened then was that, in the face of high inflation, the Fed sharply raised interest rates, causing a recession; this recession lowered inflation, and the Fed then reversed course, cutting rates again:
Indeed, the Fed again raised rates sharply to fight inflation. But events since then have failed to follow the script in two distinct ways.
First, those tariffs have so far failed to produce a recession. Instead, the economy has been remarkably resilient. Mortgage interest rates — arguably the most important place where the monetary policy rubber meets the road — have soared over the past year and a half:
However, unemployment has not risen significantly at all, which is not what most economists, including myself, predicted. Why not?
Part of the answer may be that housing demand increased in 2021-22, largely as a result of the increase in remote work, and that this increase in demand muted the usual negative impact of higher rates. This is especially true for multi-family housing, where high rents have given developers an incentive to keep building despite higher borrowing costs.
Another part of the answer may be that the Biden administration’s industrial policies — indeed, subsidies for semiconductors and green energy — have led to a boom in non-residential investment, especially manufacturing. The numbers here are truly amazing:
There may also be other factors, such as all the “revenge trips” Americans have taken as fear of Covid-19 fades. Whatever the reasons, the economy has driven higher interest rates to an extent that few expected.
Now, you might think that this means the Fed will have to push interest rates even higher. After all, don’t we need a recession to curb inflation? But here’s the other place where things have gone wrong: Despite steady job growth and continued low unemployment, inflation has actually declined. This is true even if you look at measures that try to rule out temporary factors. My preferred measure these days is “supercore,” which excludes food, energy, used cars, and shelter (because official measures of housing costs still reflect rent that ended a year ago.):
This is the measure I will be watching when new inflation numbers come in tomorrow. (PS: The Fed has a different measure of supercore – non-housing services – but when you look at the details of that indicator, it’s a dog’s breakfast of poorly measured components that I find hard to take seriously.)
Anyway, something really strange happened. I cannot think of another example in which there was such universal agreement that a recession was imminent, yet the predicted recession did not arrive.
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