Brief Update: High Inflation, High Interest Rates, but no Recession and a “Soft Landing” Ahead

The markets are finally beginning to believe that Fed Chairman Jerome Powell will be able to pull off a soft landing – what many had thought impossible: pulling the economy out of a period of rampant inflation without plunging it into recession.

In September, employment figures confirmed the strength of the economy, with 104,000 more jobs than forecast, and fears of a recession faded: “The general direction of US employment indicates that the economy is a long way from recession,” wrote Paul Donovan, chief economist at UBS, in a note published in Fortune on Monday, October 7, 2024.

What was the basis for the alarmist forecasts for 2021, 2022, 2023?

The pandemic has created major distortions in the global economy. Rising inflation, soaring oil prices and global instability led forecasters to revise downwards their estimates of economic growth for the years 2021, 2022 and 2023, increasing the likelihood of an outright economic contraction.

Inflationary surges were primarily attributable to supply disruptions caused by the pandemic, where cyclical excesses in demand, surpassing supply capacity, led to high problematic inflation.

GDP growth was expected to fall to 2.6% in December 2021 and 1.5% in May 2023 according to Federal Reserve. Such forecasts were confusing, as the economy was, in many respects, booming even then. Indeed, the U.S. labor market was strong: 6 million jobs were added in 2021, and unemployment was at a 50-year low. For example, the unemployment rate fell from 4% in December 2021 to 3.6% in May 2022.

In my post [where is the global economy headed?], I quoted Gregory Mankiw, professor of economics at Harvard University, as saying, “If the U.S. is about to enter or has entered a recession, it is unlike any other recession on record. I would be surprised if there were a recession without much job loss.” Indeed, since World War II, the U.S. has experienced 12 recessions, each with a dual characteristic: a contraction in economic activity and a rise in unemployment.

Where do we stand in 2024?

Although inflation has not returned to its 2% target - it's not far off. The Bureau of Labor Statistics reported in early September that the CPI had increased 2.5% for all items over the past 12 months.

GDP growth was and will remain strong. GDP growth was 5.7% in December 2021 and 2.1% in 2022. In 2023, GDP growth was 6.3% and 3% for the second quarter of 2024.

Strong labor market. The resilience of the labor market has been remarkable. Over the past 24 months, the unemployment rate has remained low, between 3.4% and 4.4%. The labor shortage was and still is a reality. Skilled workers are hard to find, which is driving up wages. Higher wages support household wealth and spending, which promotes economic growth.

In addition, Americans saved a lot of money during the Covid period. Also, stimulus bills approved by Congress in early 2020 triggered the largest influx of federal funds into the U.S. economy on record. Roughly $5 trillion went to households, small businesses, restaurants, airlines, hospitals, local governments, schools and other institutions grappling with the shock inflicted by Covid. This financial rescue helped the U.S. economy to recover faster than expected.

Final thoughts

Given the unique circumstances and unchartered territory we found ourselves in, gauging the health of the economy over the past few years was a complex exercise that required analysis beyond the usual indicators.

For many economists, the ‘short-lived (3-month), manageable recession’ we experienced during the pandemic was the result of a supply-side driven disruption to the economy. Once the problems of supply delivery times, inventories and backlogs were resolved, supply would bounce back again, and so would growth.

Furthermore, to account for the inaccuracies in growth forecasts, the impact of the pandemic led to significant and unexpected economic adjustments (economic stimulus bills and excessive savings). Stimulus measures and savings encouraged American consumers to open their wallets and spend, thereby sustaining economic growth. In the end, there was no recession, despite high inflation and high interest rates. The remedy (high interest rates) cured high inflation.