“Overall economic data has come in stronger than expected,” says Goldman Sachs in its latest note. “The economy has been incredibly resilient,” adds the bank’s CEO, David Solomon. The predicted recession remains on the edge of an ever-distant precipice, one that seems to have retreated from the end of this year to early next, then to late next year, then to 2025. Indeed, secretary of the treasury Janet Yellen now says “my odds of it, if anything, have gone down – because look at the resilience of the labor market, and inflation is coming down.”
Short and Shallow Not Long And Deep
Also, many prognosticators who still believe a recession is in our future have moved from long-and-deep to short-and shallow. The Conference Board’s Dana Peterson reports that “an outsized 87 per cent” of CEOs are in the short-and-shallow camp, while only 6 per cent anticipate a deep recession with global spillover, and 7 per cent expect no recession at all. Only 20 per cent anticipate layoffs, while 33 per cent plan to continue hiring and 46 per cent say they will stand pat.
Or Perhaps Not At All
The economy continues to surprise on the upside.
When the year began, the Federal Reserve Board’s monetary policy committee expected the US economy to grow at an annual rate of 0.5 percent; it has grown four-times faster, and the Atlanta Fed is estimating the economy grew at a 2.2 per cent rate in the recently concluded second quarter.
New home sales jumped by 12.2 per cent in May from the April level, and were 20.0 percent higher than in May 2022. The National Association of Home Builders reports that its members’ optimism rose every month in the first half of this year. Lest you forget that good news for builders can be bad news for the Fed, the price of framing lumber jumped 11 per cent in a few weeks.
The word repeatedly used to describe consumer spending is “resilient”, an adjective it shares with the labor market. Consumer have accumulated enough stuff, with the exception of cars that have been in short supply, while locked at home in constant contact with Amazon as their sole visitor, and so have switched their spending to services, where “There has been an uptick in growth …” says Anthony Nieves, of data-gatherer ISM.
An Unlocked Supply Side
The healthy demand side of the economy is no longer bumping against a supply side so disorganized that it contributed to price inflation. “The supply chain side [is] … in a much better state than it was a year or two ago,” Amazon CEO Andy Jassy told a CNBC interviewer. Lead times are shortening, transportation is more readily available, materials are available – “a180-degree change from a year ago” according to a Bloomberg survey.
Which undoubtedly contributed to healthy sales of new vehicles in the second quarter. Total vehicle sales are 13 per cent above last year’s levels. GM reports an almost 19 per cent jump, Ford almost 10 percent, with its F-Series of trucks leading the way. To remain in step with their brethren in the macro-forecasting business, auto experts are predicting a slowdown in the second half of the year. Never mind that the average age of the approximately 280 million vehicles on the road is 12.5 years.
Boom With A Bit Of Cooling, Not Bust?
We might be witnessing an emerging boom as the resilient, flexible US economy adjusts to the post-pandemic era – a take-off rather than some sort of landing, hard or soft. Perhaps the Fed should stop wondering how much pain it must inflict on the economy to get inflation down to a New Zealand-themed 2 per cent, and instead ask what combination of inflation and growth is best for America.
This is not to deny that evidence of cooling can be found in the huge data dump every month, or that inflation remains a problem. The economy added only 209,000 jobs in June (revisions to follow), well below May’s revised 306,000 and the 339,000 average last year. But average hourly earnings rose by 4.4 per cent as workers exploit the availability of almost 10 million job openings, 1.6 for every unemployed worker. The Fed will take continued wage increases of that magnitude as proof it has more work to do to get inflation down to its 2 per cent target. While it does that work – probably one or two 0.25 per cent increases in the bank’s benchmark interest rate – it is time for it to consider whether it really intends to squeeze the economy to get to its 2 per cent target. Action need not be a substitute for thought: the Fed can raise rates and study its target at the same time. Incoming data can serve two purposes: informing action now, and providing grist for the intellectual mill that produces the underlying rational for such action.
If Three Can Be Two, Can Four Be Three?
Fed chair Jay Powell, asked about the possibility of raising the target, said, “We’re not considering that. We’re not going to consider that. Under any circumstances.” Lest you think a central banker is capable of an unequivocal statement, he added, “there might be a longer-run project” to take a fresh look at the 2 per cent target.
Now might be the time to start. David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, believes a 2.5 per cent target “might be too low”, hinting that a 3 per cent solution might be about right. Johns Hopkins University economist Lawrence Ball goes further, arguing, “If 4 per cent was low enough for Paul Volcker”, credited with stuffing the inflation genie Jimmy Carter had released back into its bottle, “it should be low enough for all of us…”. Olivier Blanchard and Etienne Gagnon, economists who have held senior positions at the IMF and the Fed, respectively, agree with Ball.
The Economist says the trade-offs required to get inflation to 2 per cent “look nightmarish,” a 6.5 per cent unemployment rate according to one study. That would mean throwing 5 million people out of work. Instead of all the pain that would be required to get inflation to 2 per cent, “4% may be the new 2%”, the magazine jests seriously. A 4 per cent target is sufficiently close to the current inflation rate of 4.6 per cent (according to the bank’s preferred measure) to bring the bank close to “mission accomplished” rather than with a lot of tightening still to do. Other central banks might notice. Powell might find it difficult to avoid discussing this at the international central bank conclave in Wyoming in August.
The New York Fed reports that consumers are expecting inflation to run at a rate of 3.0 per cent three years from now, and 2.7 per cent in five years. The median forecast of Fed policy makers is for its benchmark interest rate to be 2.5 per cent in the “longer run”. Why disappoint all of those people? Unless … the very act of changing the target changes their expectations.
Always Get The Question Right
Even if empirical studies support accepting pain for the gain of lowering inflation to the current 2 per cent target, we will have made policy based on data rather than reliance on a three-decade old pronouncement by a New Zealand minister. Ask the wrong question – “How do we get inflation down to the target that suited the sheep-based economy of New Zealand thirty years ago?” – we might ask, “What is the rate of inflation that maximizes the combination of growth adequate to maintain full employment and stable prices?”, with both defined by sound data.
Call all of this a thought experiment.