Chapters
A painful adjustment
There is no doubt that the rolling shocks delivered by the post-Covid-19 economic regime have made forecasting particularly challenging. At the same time, market economists have been continuously on the defensive. They have delivered at least five false alarms in recent years, as catalogued in a thoughtful recent book on forecasting by Philip Carlsson-Szlezak and Paul Swartz1:
- In early 2020, when the Covid-19 pandemic took hold, a narrative of a new Great Depression took hold. Yet by the first quarter of 2021, as a result of the willingness of policymakers to lean against it, economic output in the US had bounced back to its pre-Covid level.
- In 2021, the market narrative veered in the opposite direction as it became clear that the recovery was going to be robust. The narrative became one about a “Roaring Twenties.” Digital enablers of the lockdown economy, like Zoom and Teladoc were expected to deliver a tremendous boost to productivity. Yet little of that transpired, and investors in the so-called “pandemic winners” were left nursing losses.
- In 2021 and 2022, when post-pandemic inflation peaked higher and later than many expected, many economists entertained the notion of a structural break in the inflation regime, back to the 1970s, when inflation expectations were unmoored. Even if inflation over the next decade is higher than it was in the 2010s, the structural break narrative has not yet come to pass. Inflation did move lower, reflecting a cyclical and idiosyncratic mismatch of supply and demand rather than the structural break of the 1970s.
- In 2022, as the Fed raised rates at the fastest pace in decades, investors expected EM currencies and assets to be under pressure, triggering defaults and capital flight. Yet emerging markets have successfully weaned themselves from short-term dollar funding in recent years, and there was no systemic EM crisis.
- Starting in early 2022 and early 2023, a narrative of an imminent and inevitable recession took hold in rich countries. Forecaster models showed sharply higher recession odds. By end-2022, 85% of economists surveyed expected a recession over the next 12 months.2 The Economist’s World in 2023 publication, written by the newspaper’s editor, explained “Why a global recession is inevitable in 2023.”3 This went hand-in-hand with the view that inflation would not moderate without much higher unemployment, the key determinant of a recession in service-sector-dominant advanced economies. Yet by mid-2024, US unemployment remained near record lows despite a slowing labour market, and inflation showed continued signs of moderating.
The repeated failure to predict the course of the economy can be illustrated by the famous fan chart showing the failure of the Federal Funds Futures market to forecast the Federal Funds rate in both directions over the last few years.4
The least interesting conclusion to be drawn is that models can be ineffective or economists frequently exhibit a pigheaded form of hubris. They can, and economists do. But this is also a kind of analytical nihilism; it closes off an understanding of the world. The truth is market economists are a reasonably undogmatic and informed group of professionals. They are used to dealing with economic uncertainty. That they got it wrong so badly should be interesting.
It’s therefore worth focusing on the specific analytical errors involved, particularly in the last example of the narrative whiplash—the prediction of the “inevitable recession” of 2023.
That economists expected a recession in response to a rapid monetary policy tightening in 2023 is fairly understandable. Central banks had delivered the third fastest tightening cycle in at least fifty years. The only faster cycles occurred in 1980 and 1973 and both delivered a so-called hard landing, periods when employment and output declined considerably. When former vice-chair of the Federal Reserve Alan Blinder catalogued 11 Fed tightening cycles since 1965, he found that just three led to an unambiguously “soft landing,” i.e. stabilising or reducing inflation with no recession.5 Those episodes had involved Federal Funds increases of 175 basis points (1965-1966), 315 basis points (1983-1984), and 310 points (1993-1995).
Here, instead, was a rate increase trajectory worth 550 basis points, coming after rates had hit a 5000-year low6, a decade of easy money, a proliferation of new and untested financial business models (e.g. private credit, some of the less disciplined parts of private equity), a heap of “zombie companies” that were thought only to have been funded because of the zero interest rate environment. Surely, we would see a painful adjustment.
Figure 1: Historic Fed hiking cycles (% over months)
Source: Ninety One
References
1 Carlsson-Szlezak, P. and Swartz, P., Shocks, Crises, and False Alarms: How to Assess True Macroeconomic Risk, Harvard Business Review Press, July 2024.
2. “US unemployment rate set to surpass 5.5%, economists predict,” Financial Times, December 7 2022. The survey is the FT-Booth Survey of December 2 2022.
3. Zannie Minton Beddoes, “Why a global recession is inevitable in 2023,” The Economist: The World Ahead 2023, November 18 2022.
4. Slok, T., “The forecasting record of the Fed and the Market,” Apollo Academy, May 7 2024.
5. Blinder, A., “Landings, Soft and Hard: The Federal Reserve, 1965-2022,” Journal of Economic Perspectives, Volume 37, Number 1—Winter 2023, Pages 101-120.
6. Haldane, A., “Stuck,” Bank of England, 30 June 2015. Chart 5.
7. Mandelman, F., and Meyer, B., “Lessons from the Past: Can the 1970s help inform the future path of monetary policy,” Policy Hub: Macroblog, Federal Reserve Bank of Atlanta, August 31 2022
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8. This is the view articulated most clearly by former head of OECD forecasting John Llewellyn, “Yes, the US economy looks resilient now—but that may not last,” Financial Times, November 13 2023.
9. D’Amico, S., and King, T., “Past and Future Effects of the Recent Monetary Policy Tightening,” Chicago Fed Letter, No. 483, Federal Reserve Bank of Chicago, September 2023.
10. Stein, J, and Pager, T., “Larry Summers has President Biden’s ear — but not always his support,” The Washington Post, October 3 2022.
11. It was not always clear who had the President’s ear at any given point. “A White House official said the president has spoken with Summers about the same number of times since taking office as he speaks with Yellen every month.” Stein, J, and Pager, T., “Larry Summers has President Biden’s ear — but not always his support,” The Washington Post, October 3 2022.
12. “The economists are in a much more reactive position than they were in the Obama administration,” said one senior Biden administration official, speaking on the condition of anonymity to reflect internal dynamics. “They are being told, ‘Here’s what the policy is.’ There may be some flexibility to change things on the edges, but in general, by the time they weigh in, the policy has already been set.” Also: “The meeting set off fresh speculation inside the White House about the influence of what some aides jokingly call Biden’s “shadow” director of the National Economic Council — a position actually held by Brian Deese — and the uncertain stature of Treasury Secretary Janet L. Yellen, who has sometimes struggled to get Biden to back her recommendations.” Stein, J, and Pager, T., “Larry Summers has President Biden’s ear — but not always his support,” The Washington Post, October 3 2022.
13. The quote is from Robert Wolf, an Obama-era economic adviser who maintains ties to the Biden White House. “We have to be feeling really good about what’s taken place.” Cancryn, A., “Biden’s economic success story could fall flat among people still struggling,” Politico, September 26 2022.
14. Cancryn, A., “The White House has one problem that rules them all: Gas prices,” Politico, May 31, 2022.
15. “Missing: the 2022 recession,” FT Alphaville, Financial Times, February 3 2023.
16. Cancryn, A., “Biden’s economic success story could fall flat among people still struggling,” Politico, September 26 2022.
17. “US Economic Confidence Dips for a Second Month in a Row,” Gallup, May 31 2024.
18. "Summers Says US Needs 5% Jobless Rate for Five Years to Ease CPI." Bloomberg, June 20 2022.
19. "Inflation, Recession, and the Federal Reserve," The New York Times, June 22 2022.
20. "Forecast for US Recession Within Year Hits 100% in Blow to Biden,” Bloomberg, “October 17 2022.
21. "US Recession Probabilities Reach 96 Percent,” The Conference Board, September 29, 2022.
22. Stein, J, and Pager, T., “Larry Summers has President Biden’s ear — but not always his support,” The Washington Post, October 3 2022.
23. Stein, J, and Pager, T., “Larry Summers has President Biden’s ear — but not always his support,” The Washington Post, October 3 2022.
24. Moore, E., and Chu, H., “Tracking Trump's endorsements: Here's how his picks have fared in primaries,” NPR, September 8 2022.
25. Rakich, N., “Why Trump Is Favored To Win The 2024 Republican Presidential Primary,” FiveThirtyEight, November 15 2022.
26. “Fiscal Policy in the Great Election Year: The IMF Fiscal Monitor,” International Monetary Fund, April 2024. The fiscal impulse is the change in the cyclically adjusted primary fiscal balance from one year to the next. It is designed to assess the impact of fiscal policy on the economy. It makes distinctions between changes in the fiscal balance due to economic cycles and those due to discretionary fiscal measures. The measure is sometimes criticised because it depends on unobservable “output gaps,” though it remains indispensable. See: Efstathiou, K., “The campaign against ‘nonsense output gaps,” Bruegel, 17 June 2019.
27. Sheiner, L., and Conner, A., “Why did the budget deficit grow so much in FY 2023? And what does this imply about the future debt trajectory?” Brookings Institute, November 22, 2023.
28. In a way treating monetary policy and fiscal policy as separate levers is misleading because the 2022-2023 monetary policy tightening effort itself was the result of previous loosening in fiscal policy, starting with Trump’s Covid stimulus measures, but also the Biden administration’s stimulus efforts in early 2021, spurred by the Democrats unified control of Washington. That was a wager on supercharging what was already a very strong Covid recovery. It did spur growth, but it also spurred inflation as supply constraints could not deliver on the demand unleashed by the stimulus plans. Because inflation rose and proved stickier than hoped, the Fed aggressively moved to slow the economy in 2022, undoing part of the effect of the Biden stimulus.
29. Weekly US Ending Stocks of Crude Oil in SPR, US Energy Information Administration, as of 19 August 2024.
30. “Former Trump energy secretary says releasing oil from reserves is ‘bad policy choice,’” CNBC, November 24 2021.
31. Katz, D., and Jacobs, E., “Stop draining the strategic petroleum reserve,” City Journal, April 26 2024.
32. Roubini, N., and Miran, S., “ATI: Activist Treasury Issuance and the Tug-of-War Over Monetary Policy,” Hudson Bay Capital, July 2024.
33. Roubini, N., and Miran, S., “ATI: Activist Treasury Issuance and the Tug-of-War Over Monetary Policy,” Hudson Bay Capital, July 2024.
34. “Biden's Treasury accused of trying to juice U.S. economy pre-election,” Axios, August 5 2024.
35. “Biden's Treasury accused of trying to juice U.S. economy pre-election,” Axios, August 5 2024.
36. “FACT SHEET: President Biden Announces Student Loan Relief for Borrowers Who Need It Most,” White House, August 24 2022
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37. Swagel, P.L., “Re: Costs of Suspending Student Loan Payments and Cancelling Debt,” Congressional Budget Office, September 26, 2022.
38. “‘Morning in America’ eludes Biden, Despite Economic Gains,” New York Times, November 7 2023
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39. Orrenius, P.M., Pranger, A., Zavodny, M., Dhillon, I. “Unprecedented U.S. immigration surge boosts job growth, output,” Federal Reserve Bank of Dallas, July 2 2024
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40. Camarota, S., and Zeigler, K. “Foreign-Born Population Grew by 5.1 Million in the Last Two Years,” Center for Immigration Studies, May 13 2024
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41. “The Budget Geeks Who Helped Solve an American Economic Puzzle,” Bloomberg, June 3 2024.
42. Net immigration is the sum of individuals who enter the country minus those who leave. Entries can be permanent or temporary but exclude short-term visitors such as tourists. Entries can also be legal, when people come with U.S. government visas, or otherwise, such as humanitarian migrants (asylum seekers and, more recently, humanitarian parolees) and unauthorized immigrants.
43. Peng, E., and Walker, R., “US Daily: Do the Official Statistics Fully Capture the Recent Surge in Immigration?” Goldman Sachs Economic Research, April 17 2024.
44. Orrenius, P.M., Pranger, A., Zavodny, M., Dhillon, I. “Unprecedented U.S. immigration surge boosts job growth, output,” Federal Reserve Bank of Dallas, July 2 2024.
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46. Edelberg, W., and Watson, T., “New immigration estimates help make sense of the pace of employment,” The Hamilton Project, Brookings Institute, March 2024, Figure 5.
47. Edelberg, W., and Watson, T., “New immigration estimates help make sense of the pace of employment,” The Hamilton Project, Brookings Institute, March 2024.
48. Edelberg, W., and Watson, T., “New immigration estimates help make sense of the pace of employment,” The Hamilton Project, Brookings Institute, March 2024.
49. “Effects of the Immigration Surge on the Federal Budget and the Economy,” Congressional Budget Office, July 23 2024, Data Underlying Figures and Tables, Figure 4.
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51. “Effects of the Immigration Surge on the Federal Budget and the Economy,” Congressional Budget Office, July 2024, Figure 2.
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55. Peng, E., and Mericle, D., “Has the Immigration Rebound Helped to Solve the Inflation Problem?” Goldman Sachs Economic Research, May 5 2024.
56. Peng, E., and Mericle, D., “Has the Immigration Rebound Helped to Solve the Inflation Problem?” Goldman Sachs Economic Research, May 5 2024.
57. Walker, R., “US Daily: Upgrading Our GDP and Payrolls Forecasts to Reflect Elevated Immigration” Goldman Sachs Economic Research, March 17 2024.
58. Sahm, C., “Sahm-thing more on the Sahm rule,” Stay-At-Home-Macro (SAHM), Substack, July 24 2024.
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60. Briggs, J. and Kodnani, D., “Global Economics Comment: Why Is DM Immigration So Elevated?” Goldman Sachs Economic Research, December 20 2023.
61. Orrenius, P.M., Pranger, A., Zavodny, M., Dhillon, I. “Unprecedented U.S. immigration surge boosts job growth, output,” Federal Reserve Bank of Dallas, July 2 2024.
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63. Orrenius, P.M., Pranger, A., Zavodny, M., Dhillon, I. “Unprecedented U.S. immigration surge boosts job growth, output,” Federal Reserve Bank of Dallas, July 2 2024.
64. The CBO estimate for “got-aways” in FY23 are that 860,000 aliens entered the United States illegally “without encountering a CBP official”. In other words, nearly the population of Charlotte, N.C., America’s 15th largest city.
65. Orrenius, P.M., Pranger, A., Zavodny, M., Dhillon, I. “Unprecedented U.S. immigration surge boosts job growth, output,” Federal Reserve Bank of Dallas, July 2 2024.
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67. Wu, A., “Why Illegal Border Crossings Are at Sustained Highs,” New York Times, October 29 2023.
68. Parti, T., and Hackman, M., “Why Immigration Is Now the No.1 Issue for Voters,” Wall Street Journal, April 5 2024.
69. Chishti, M., Bush-Joseph, K., and Putzel-Kavanaugh, C., “Biden at the Three-Year Mark: The Most Active Immigration Presidency Yet Is Mired in Border Crisis Narrative,” Migration Policy Institute, January 19 2024.
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73. “Citing Costs of Migrant Care, Adams Calls for More Budget Cuts,” New York Times, September 9 2023.
74. “New York City’s Fiscal Crisis That Never Was,” Bloomberg, July 2 2024.
75. Edelberg, W., and Watson, T., “A More Equitable Distribution of the Positive Fiscal Benefits of Immigration,” The Hamilton Project, Brookings Institute, December 2022.
