What recession? Inflation, GDP offer hope for ‘soft landing’

Perhaps a 2023 recession can be avoided after all.

Consistently falling prices alongside a stronger-than-expected fourth-quarter gross domestic product (GDP) and next week’s anticipated less aggressive interest rate hike from the Federal Reserve are changing economists’ tune and renewing hopes about the overall health of the economy.

The personal consumption expenditures price index (PCE) cooled to 5 percent annually last month from 5.5 percent in November, Commerce Department data showed Friday, mirroring a drop in the consumer price index (CPI) from 7.1 percent to 6.5 percent over the same period. The CPI has dropped every month since June, when it peaked at 9.1 percent annually.

The day before, data came down showing that the U.S. economy grew at an expectation-beating rate of 2.9 percent in the last three months of the year, down slightly from 3.2 percent in the third quarter but high enough to result in annual growth of 2.1 percent. The GDP contracted in the first and second quarters of 2022 following the huge recovery of 2021.

U.S. production levels are now basically in line with where they were prior to the pandemic, using seasonally adjusted measurements and correcting for inflation.

The positive numbers have some economists chiding market commentators for being overly pessimistic in their characterizations of the economy over the course of 2022, a year in which many Americans believed a recession had already begun.

“Worst. Recession. Ever,” University of Michigan economist Justin Wolfers joked online after the release of the GDP data.

“There’s a lot to be said about these latest GDP data, but I think the thing it underscores is that it’s now official: There was no recession in 2022. All that talk, all that energy, all that bluster, was nonsense all along,” Wolfers added.

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

“Many economists have gone way overboard in talking as if a 2023 recession is all but inevitable. I would put the odds of a recession this year at something like 35 percent,” Frankel said in an email to The Hill.

The strong U.S. recovery along with the rapid drop in consumer prices is leading some commentators to revisit the characterization of inflation as “transitory” — a notion that had been disavowed by economists over the summer as annual price increases climbed above 9 percent, leading even Treasury Secretary Janet Yellen to say that she had been wrong about inflation and didn’t fully understand what was causing it.

“At this point the burden of proof lies on anyone claiming that we had more than a, well, transitory inflation spike that’s mostly behind us,” New York Times economics columnist Paul Krugman wrote online last week.

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

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

University of Massachusetts economist Arin Dube pointed the finger at “public-facing economists” for failing to accurately convey the strength of the economic recovery after the coronavirus pandemic.

“It’s not just politicians and the press,” Dube wrote online Thursday. “Too many public-facing economists have downplayed the recovery over the past two years.”

Perhaps the most vocal of those economists has been former Treasury Secretary Larry Summers, who made the case time and again that inflation was a much more persistent problem than the Fed was making it out to be and would require years of high unemployment in order to correct.

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

“In other words, we need two years of 7.5 percent unemployment or 5 years of 6 percent unemployment, or one year of 10 percent unemployment,” he said.

In fact, inflation has been falling even as unemployment has remained around a 50-year low of 3.5 percent, suggesting that price spikes during the pandemic have less to do with the labor market than with other factors including supply shocks and profit maximization tendencies among firms.

The reason that so many of these estimates have been off is outdated modeling and economic thinking, according to investor and founder of Westwood Capital Dan Alpert.

“The people who have their academic careers and their business forecasting careers based on economic modeling and macroeconomics that grew up from micro-fundamentals over the 30 years from, say, the late 1970s until the end of the century — they’re heavily invested in a way of looking at the world that ties into … labor’s impact on prices,” Alpert told The Hill in an interview.

“But those models don’t really apply to a fully fiat world where you really don’t have constraints on currency and you’ve got credit developing through multiple channels and you have massive asset inflation without having a lot of goods and services and wage inflation,” he said.

But even amid all the positive data, there are some potential signs that the U.S. economy could be slowing down. 

Friday’s PCE numbers showed a drop of 0.2 percent in consumer spending in December, larger than the 0.1 percent drop in November. The drop in spending was confined mostly to the goods sector.

The Philadelphia Federal Reserve anticipates more sluggish growth in 2023, at a rate of 0.7 percent for the year, as the Fed continues with its program of monetary tightening.

“Overtightening of monetary policy would drive the world economy into an unnecessarily harsh slowdown, an outcome that could be avoided,” the United Nations economists warned in their World Economic Situation and Prospects report released Wednesday.

“While it is still too early to determine whether central banks in developed countries, in particular in the United States and European countries, have overtightened monetary policy, this risk should not be ignored. The ‘taper tantrum’ in 2013 remains fresh in memory, where the Federal Reserve’s announcement that it would taper bond purchases immediately led to sharp increases in government bond yields. Treasury bond sell-offs spilled into corporate bond markets and disrupted equity markets,” they wrote.