The traditional holiday question to children, “Have you been naughty or nice?” is a perfect lead-in to the economic outlook in 2023. As 2022 ends and 2023 begins, we face two economic challenges — inflation and recession. The big questions are, will inflation return to normal in 2023, and if so, will it take a recession to do so?
Actually, we’ve already seen some progress on inflation. Year-over-year inflation was over 9% in the summer, but recently it’s been near 7%. That doesn’t seem like much, but at least the rise in prices has been slowing.
But the decline in the price of gas at the pump has certainly brought smiles to our faces. After the national price per gallon jumped to over $5 in June, we’re now seeing gas prices near $3.
Interest rates are another matter. If you’re borrowing money for a home, vehicle, or other big-ticket item, you’re now paying more than twice as much today than a year ago. Yet the Federal Reserve has signaled more rate hikes are ahead.
Most people are still struggling as wages and salaries have not kept up with prices. 2022 has been a rough year. Will it get any better in 2023?
One piece of good news is that supply-chain problems have eased. A measure shows the intensity of supply problems improving 75% since 2021. As a result, sellers have more inventories and delivery times have returned to pre-pandemic levels. These improvements by themselves should moderate inflation.
But will it be enough? The Federal Reserve doesn’t think so. The Federal — the “Fed” — is the nation’s central bank. It has the ability to create money, and it uses that power to nudge interest rates up and down. If the Fed wants to stimulate borrowing and spending, it lowers interest rates. It did this at the height of the pandemic, which — among other things — created massive home buying. But if the Fed wants to moderate borrowing and spending, it pushes interest rates higher.
In the Fed’s view, we are trying to spend more than the economy can provide. This puts upward pressure on prices, meaning the inflation rate jumps. Even though the supply chain is improving, the Fed still thinks consumer spending is running too hot.
But part of today’s problem is a result of the Fed. When the pandemic was raging, the Fed’s key interest rate was zero. This was designed to boost spending. The Fed has now raised its key rate to over 4%, and most economists think the rate will go higher.
Of course, the Fed doesn’t want to increase interest rates so much so as to create a recession. Unfortunately, one of the best predictors of a recession — a measure called the “inverted yield curve” — is giving its strongest forecast of an upcoming recession in 40 years.
Thus, I — and many economists — are predicting a recession for some period in 2023. The good news is, it will likely be relatively mild. Still, even a mild recession would add between 50,000 and 100,000 North Carolinians to the unemployment rolls.
If a recession does happen in 2023, look for sectors like real estate, construction, manufacturing, retail, and leisure/hospitality to be hit the hardest. Businesses selling necessities like food, health care, education, and energy, will be less negatively impacted.
When will we get past the twin challenges of inflation and recession? I think a good expectation is late 2023 or early 2024.
If this good news occurs, does that mean “all is well.”? Unfortunately, the answer is no. Inflation will continue, but at a lower level. Workers will begin to see their pay raises outpace price hikes. But based on past experiences, it could take years for households to reach the standard of living they had prior to the double punch of inflation and recession.
This reality is a good reason why our policymakers should do everything they can in the future to avoid the trauma of inflation followed by the medicine of recession.
Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.