Inflation was a big story of this past year, and while it isn’t going away anytime soon, the prospect of a recession will likely be an even bigger story in 2023.
Those hoping for the economy to return to its pre-pandemic equilibrium of low unemployment and moderate price increases will have to wait as that scenario appears very unlikely. Broadly speaking, it seems as though 2023 will feature declining, but still high, inflation and a high risk of a broad-based economic downturn.
While the two are very different economic phenomena, both the country’s high inflation and a likely recession are tied.
To fight inflation, the Federal Reserve raises interest rates in order to slow demand, which causes prices to fall. But declining demand and lower spending mean that growth could slow and falter, a scenario that if bad enough turns into a full-blown recession. So the Fed’s actions are the key to understanding both inflation and the possibility of a recession in 2023.
What has the Fed done so far?
This past year will go down in history as one of the most tumultuous in Fed history. As it became apparent that inflation was no longer “transitory,” the central bank began jacking up rates and became more hawkish as the year dragged on, at one point hiking rates by 75 basis points four times in a row, akin to a dozen conventional hikes.
Inflation appears to have started to be tamped down by the tightening. A report on the consumer price index on Dec. 13 found inflation ticked down to 7.1% for the 12 months ending in November — marking five straight months of declines.
Still, inflation is running far above the Fed’s preferred level of 2%. Fed Chairman Jerome Powell, following the last Federal Open Market Committee meeting of 2022, noted that the central bank still doesn’t see enough evidence that prices are meaningfully dropping to stop the rate hikes, meaning that there will likely be more in store for this coming year.
By mid-December, the Fed’s target was 4.25% to 4.5%, the highest it has been since before the financial crisis in 2008. A survey of Fed participants released after the meeting showed that most foresaw the target rate rising to 5% to 5.25% in 2023, which implies another 75 basis points of hikes still in store.
What will inflation look like in 2023?
It is widely expected that inflation will remain high throughout the coming year, although the growth will be, thankfully, much less than in 2022.
The Fed’s preferred gauge of inflation is the personal consumption expenditures index. The most recent PCE index data showed that inflation was running at 6% in the 12 months ending in October. Core PCE inflation, which strips out energy and food prices and is generally less volatile, was at a 5% year-over-year rate.
What will next year’s economic slowdown look like?
There is universal agreement that the economy will falter next year, although there is a high degree of uncertainty as to how bad that downturn will be and whether it will constitute a mild or more serious recession.
Economic modeling by Bloomberg assigned a 100% chance of a recession occurring by next October, and the Conference Board, based on its probability model, also predicted a 96% chance of the economy entering into a recession in the next 12 months. The group also predicted that the last quarter of 2022 and the first quarter of 2023 will experience negative real GDP growth rates.
There isn’t a single government agency that has the authority to declare a recession. Instead, those in government and most economists look to the National Bureau of Economic Research to declare one. The NBER is a private group that is seen as an authority on the matter.
NBER defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months,” although there has been a historical precedent of labeling two consecutive quarters of negative economic growth recessionary.
Both the first and second quarter of this past year ended in the red, and many quickly declared the country to be in a recession, but the NBER never declared one, and most economists agreed the United States didn’t enter one because of the strong labor market. There has never been a recession with the ultralow unemployment that was experienced in 2022.
But the rosy employment situation is not expected to last. Economists foresee jobs being lost as the economy slows in 2023. Fed officials this week predicted that the unemployment rate will rise from the 3.7% level it is at now up to 4.6% by the end of this coming year. They also project the unemployment rate remaining around that level through 2025.
Citi Global Wealth Investments recently predicted that the unemployment level could tick up to 5.25%, which would result in a loss of some 2 million jobs.
“We believe that the Fed’s rate hikes and shrinking bond portfolio have been stringent enough to cause an economic contraction within 2023,” the economists said in the report. “And if the Fed does not pause rate hikes until it sees the contraction, a deeper recession may ensue.”