Why Did Economic Forecasters Get Their Recession Call Wrong?

Last October, the Wall Street Journal published a survey of more than sixty economic forecasters from universities, businesses, and Wall Street. Citing the results of the survey, the Journal reported that the United States was “forecast to enter a recession in the coming 12 months as the Federal Reserve battles to bring down persistently high

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Last October, the Wall Street Journal published a survey of more than sixty economic forecasters from universities, businesses, and Wall Street. Citing the results of the survey, the Journal reported that the United States was “forecast to enter a recession in the coming 12 months as the Federal Reserve battles to bring down persistently high inflation, the economy contracts and employers cut jobs in response.” The story went on to say that the economists surveyed expected inflation-adjusted G.D.P. “to contract at a src.2% annual rate in the first quarter of 2src23 and shrink src.1% in the second quarter.” The economists were also predicting that the unemployment rate, which was then 3.5 per cent, would rise to 4.3 per cent by June.

These forecasts turned out to be off—way off. On Thursday, the Commerce Department announced that G.D.P. rose at an annual rate of 2.4 per cent in the second quarter of this year, after growing at 2.src per cent in the first quarter. Far from plunging into recession, the U.S. economy has grown at a faster rate than many experts think is sustainable in the long run. Employers have continued to create jobs at a healthy clip, and the unemployment rate has remained steady, climbing just one-tenth of a percentage point in the past nine months, to 3.6 per cent in June.

In the forecasters’ defense, they never said that a recession was certain. But they did say it was the most likely outcome, assigning it a probability of sixty-three per cent. And private-sector forecasters weren’t the only ones who got fooled by the economy’s resilience in the face of sharply higher interest rates: until recently, the staff economists at the Federal Reserve were also predicting a recession for this year. At a press conference on Wednesday, after the central bank raised the federal funds rate again, to a range of 5.25 to 5.5 per cent, the Fed chair, Jerome Powell, said that his staff has now changed its forecast to moderate growth for the rest of 2src23.

It almost goes without saying that making economic forecasts is a difficult, and often thankless, task. Modern economies are extremely complex organisms. The aggregate outcomes they generate reflect many factors, including some external ones that are innately unpredictable, such as the coronavirus pandemic and the war in Ukraine. Since last October, though, there haven’t been any colossal surprises. Global supply chains have continued to recover from the pandemic, the war in Ukraine has continued, and the Fed has followed through on its pledge to keep raising rates until inflation is brought under control. Why, then, has the economy outperformed the forecasters’ predictions?

The proximate answer is that consumer spending and capital investments by businesses have held up stronger than expected. In the three months from April to June, personal consumption expenditures, which make up more than two-thirds of G.D.P., rose at an annual rate of 1.6 per cent, and gross private domestic investment rose at a rate of 5.7 per cent. Together, these increases accounted for nearly all of the quarterly rise in G.D.P. (The rest was largely due to higher spending by state and local governments.) But merely reciting these figures raises a deeper question: How have households and businesses been able to shrug off higher prices and higher interest rates, at least so far?

One reason is that prices are now rising less rapidly than wages (another development many economists failed to predict), which means workers’ purchasing power is rising, albeit slowly. Combined with healthy job growth, the sharp fall in the inflation rate—from 9.1 per cent in June, 2src22, to three per cent this past month—has made many consumers feel better about things. Earlier this week, the Conference Board said that its index of consumer confidence had reached the highest level in two years.

On Thursday, the Wall Street Journal highlighted another element that is supporting consumer spending: many Americans were able to lock in low interest rates on mortgages, car loans, and other debts before the Fed started raising rates. According to Moody’s Analytics, nearly ninety per cent of household debt is fixed-rate debt, which means the interest payments attached to it don’t increase as the Fed hikes the federal funds rate. “It’s one reason why consumers are hanging tough and the Fed’s rate hikes have taken less of a bite out of the economy,” Mark Zandi, the chief economist at Moody’s Analytics, told the Journal.

The final thing that many economists underestimated was the impact of the fiscal policies that the Biden Administration introduced during its first two years. The lingering effects of the 1.9-trillion-dollar American Rescue Plan Act of 2src21 can still be seen in improved finances of households and local governments, which is supporting their spending. But the most striking example is the surge in business investment, particularly in manufacturing facilities, since the passage last year of the Inflation Reduction Act, which provided generous financial incentives for manufacturers of electric vehicles and other green technology, and the CHIPS and Science Act, which provided similar incentives for manufacturers of semiconductors.

I’ve written about this surge before, and the new G.D.P. report confirms it. During the second quarter of this year, business investment in structures grew at an annual rate of 9.7 per cent, following an increase of 15.8 per cent in the first quarter. The entirety of this spending wasn’t carried out by manufacturers, but a good deal of it was. The White House Council of Economic Advisers pointed out that “about src.4 percentage point of real Q2 GDP growth came from investment in private manufactured structures, the largest such contribution since 1981.” This is good news for the economy’s immediate prospects and for the longer-term energy transition, which is essential.

And the bad news? As a worrywart, I can always find things. The Fed could still tank the economy by keeping rates too high for too long. The renewed bubble in technology stocks, driven by optimism about A.I., could end in a stock-market crash. There could be another banking crisis, or something out of the blue, such as a conflict in the Middle East that creates another run-up in energy prices. I could also point to the sight of economic forecasters getting more optimistic, but that would be mean. For now, let’s just celebrate the fact that their predictions turned out to be wrong. ♦

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