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It’s too soon to declare victory, but the economic outlook seems sunnier than it did a year ago, and many economists are predicting a surprising win.
By Jeanna Smialek
The Federal Reserve appears to be closing in on an end result that its own economists failed to do just six months ago: returning inflation to headline levels without plunging the economy into recession.
It’s possible that a lot of things still go wrong. But inflation has eased especially in recent months, standing at 3. 1% annually, down from a peak of 9. 1% in 2022. At the same time, expansion is strong, consumers are spending, and employers continue to hire.
This mix surprised economists. Many had predicted that cooling a tough job market with many more vacancies than there were for staff would be a painful process. Instead, staff returned from the hard labor market to fill vacancies, contributing to a simple rebalancing. At the same time, healing supply chains have helped increase inventories and alleviate shortages. Costs of goods have stopped driving inflation and have even begun to bring it down.
The Federal Reserve expects “a continuation of what has been seen, which is a better balanced hard labor market without a significant increase in unemployment, a decline in inflation without a significant increase in unemployment, and a moderate expansion without a significant increase in unemployment. ” “Federal Reserve Chairman Jerome H. Powell said Wednesday.
As Fed policymakers look ahead to 2024, they are aiming squarely for a soft landing: Officials are trying to assess how long they need to keep interest rates high to ensure that inflation is fully under control without grinding economic growth to an unnecessarily painful halt. That maneuver is likely to be a delicate one, which is why Mr. Powell has been careful to avoid declaring victory prematurely.
But policymakers clearly see it coming into view, based on their economic projections. The Fed chair signaled on Wednesday that rates were unlikely to rise from their 5.25 to 5.5 percent setting unless inflation stages a surprising resurgence, and central bankers predicted three rate cuts by the end of 2024 as inflation continues to cool and joblessness rises only slightly.
If they manage to land successfully, Powell and his colleagues will have completed an enormous feat at the US central bank. Fed officials have traditionally steered the economy into a recession as they seek to curb inflation from highs like those it reached in 2022. And after several years in which Powell has been criticized for failing to anticipate the severity and duration of inflation, such a scenario has occurred. Success will most likely shape his legacy.
“The Federal Reserve looks pretty smart right now, as progress goes,” said Michael Gapen, head of U. S. economics at Bank of America.
Respondents in a normal survey of market participants through research firm MacroPolicy Perspectives are more positive than ever about the chances of a comfortable landing: 74% said it doesn’t take a recession to bring inflation back to the Fed’s target in December. a low of 41% in September 2022.
Fed employees began expecting a recession after several banks exploded earlier this year, but stopped predicting it in July.
People were glum about the prospects for a gentle landing partly because they thought the Fed had been late to react to rapid inflation. Mr. Powell and his colleagues argued throughout 2021 that higher prices were likely to be “transitory,” even as some prominent macroeconomists warned that it might last.
The Federal Reserve was forced to drastically change course when those warnings proved prescient: Inflation has already been above 2% for 33 consecutive months.
Once central bankers raised interest rates in response, they did so quickly, taking them from near 0 in early 2022 to their current diversity of 5. 25% to 5. 5% in July this year. Many economists feared that such a sharp slowdown in the economy would cause whiplash in the form of a recession.
But the call for transition is a little bigger now: the “transitional” took a long time to materialize.
Much of the reason inflation has moderated comes down to the healing of supply chains, easing of shortages in key goods like cars, and a return to something that looks more like prepandemic spending trends in which households are buying a range of goods and services instead of just stay-at-home splurges like couches and exercise equipment.
In short, the pandemic upheavals that the Fed hoped would be transitory have completely vanished. It only took years than months.
“As a charter member of team transitory, it took a lot longer than many of us thought,” said Richard Clarida, the former Fed vice chair who served until early 2022. But, he noted, things have adjusted.
The Federal Reserve’s policies have helped cool demand and prevented consumers from adjusting their long-term inflation expectations, so “the Fed deserves some credit” for this slowdown.
While higher interest rates didn’t heal supply chains or convince consumers to stop buying so many sweatpants, they have helped to cool the market for key purchases like housing and cars somewhat. Without those higher borrowing costs, the economy might have grown even more strongly — giving companies the wherewithal to raise prices more drastically.
The question now is whether inflation will continue to cool even if the economy moves at a steady pace, or whether a steeper economic slowdown will be necessary to bring it down to the end. The Federal Reserve itself expects the expansion to slow substantially next year, to 1. 4% from 2. 6% this year, based on new projections.
“They’ve done very well, and better than I had anticipated,” said William English, a former Fed economist and now a professor at Yale. “The question remains: Will inflation return to 2% without a steeper slowdown in labor and goods markets than we’ve noticed so far?
To date, the job market has shown little sign of cracking. Hiring and wage growth have slowed, but unemployment stood at a historically low 3.7 percent in November. Consumers continue to spend, and growth in the third quarter was unexpectedly hot.
While these are positive developments, they also raise the option that the economy is too dynamic for inflation to fully subside, especially in key service categories.
“We don’t know how long it will take to go the last mile with inflation,” said Karen Dynan, a former Treasury chief economist who teaches at Harvard.
Under those conditions, setting financial policy next year is likely to be more of an art than a science: If the expansion slows and inflation falls, cutting rates will be an apparent option. But what if the expansion is strong? What if the rise in inflation stopped but the expansion collapsed?
Powell expressed some of that uncertainty this week.
“Inflation continues to fall, the market for hard work continues to rebalance,” he said. “So far so good, we assume that things will get more difficult from now on, but so far it hasn’t. »
Powell, a lawyer by training who has devoted much of his career to personal capital, is not an economist and has at times expressed caution about the overly devoted use of key economic guides and models. That lack of determination toward models may show up over the next year, Bank of America’s Mr. Gapen.
It may leave the Fed chief — and the institution he leads — more flexible as they react to an economy that has been devilishly tricky to predict because, in the wake of the pandemic, past experience is proving to be a poor precedent.
“Maybe it was smart to hand over control of shipping to a guy who was skeptical of executives during the Covid period,” Gapen said.
Jeanna Smialek covers the Federal Reserve and the economy for The Times from Washington. Learn more about Jeanna Smialek
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