Antonio Doblas-Madrid, an associate professor of economics in Michigan State University’s College of Social Science, discusses the 2022 U.S. economy and what we can expect in 2023.
What are a few of the most memorable economic events of 2022?
Nationally, inflation has certainly been the big economic story. The initial surge in prices starting in 2021 was not transitory. It was persistent. It was unexpected — a surprise. Inflation has not been a big issue since the 1980s and, in fact, in the 2010s many economists worried there was too little of it, despite several rounds of monetary stimulus.
If we try to understand where inflation comes from, many of the other big economic events of the year come up. Prices balance supply and demand. Supply was down because of supply chain disruptions like the terrible war in Ukraine and continued COVID-19 lockdowns in China, while demand was up because of reopening efforts and new spending from consumers whose disposable income had been boosted by stimulus and high asset prices.
What’s expected to happen with the 2023 economy?
It is always difficult to forecast — especially now. In 2022 we saw two consecutive quarters of shrinking GDP, without a recession. The economy is finding its new normal, with firms having to carry more inventories than before, transitioning from a just-in-time model in the pre-pandemic world to a just-in-case model in which firms must be more cautious and cannot rely on smooth global supply chains. But the strength of the labor market, as well as the lack of signs of financial distress, make me optimistic that the economy will avoid recession and remain stable, perhaps with modest growth, in 2023.
What’s predicted to happen with inflation?
This is another factor that makes me optimistic. The latest numbers on inflation, released in December, show that prices in November grew, but at a slower pace. It seems that the changes in monetary policy that have been implemented and announced throughout the year are working. With employment still strong, the Federal Reserve Board can stay the course. It does not seem like it will be pressured to backtrack before the job of stabilizing prices is done.
What can the Federal Reserve Board do to ease inflation?
The Fed can keep doing what it has been doing, which is raising the short-term interest rate, shrinking its balance sheet by selling or letting bonds mature without rolling them over and providing forward guidance, essentially, letting market participants know what’s going on. Fed Chair Powell has consistently communicated throughout the year that the board is committed to restoring price stability.
What’s predicted to happen with interest rates?
I would expect more rate increases, but smaller. Instead of 75 basis points, I think we will see 50 basis point hikes and, potentially, 25 basis point hikes. I would not be surprised if the headline, or short-term, interest rate a year from now was somewhere between 5% and 6%, so about 1.5% higher than now. Longer-term rates are even harder to predict because they are set by the market, not the Fed. They have stabilized, or even fallen from their high set earlier in the year. If this continues, the effect of further rate hikes by the Fed on consumer rates, like mortgage rates, could be more muted.
What’s predicted to happen with gas prices?
This has been one of the toughest symptoms of inflation. High gas prices have inflicted pain on many households through the year, as it is often impossible to avoid this expenditure. And in other countries, notably Europe, the disruption of gas imports from Russia has led to high heating bills.
Oil and gas prices depend heavily on geopolitical events like the Russia-Ukraine war, which are even more difficult to predict than the Fed. As far as oil prices are concerned, the situation is not as dramatic as it was in March or June — with a barrel of oil over $120 — especially since the U.S. is also a major producer. A barrel costs less than $80 now. Fingers crossed, but in the absence of new surprises, and with the world’s other biggest economy, China, slowing down, I would expect the stabilization to continue.
What’s expected to happen with housing prices?
Housing prices are cooling after what I see as overheating due to pandemic stimulus. Virtually all markets: Equities, bonds, commodities and crypto set record highs in 2021, as both the U.S. Department of the Treasury and the Fed took unprecedented measures to support incomes. While this was effective in protecting the economy from the pandemic, it also inflated assets, and that air is coming out now.
House prices cannot continue to rise at extraordinary rates forever because nobody would be able to afford a house. I do not see this correction as problematic since financial regulation is now better than in 2008. Back then, lending without credit standards — think products like NINJA, or no income, no job and no assets loans — was common, as well as complicated securities and derivatives that nobody really understood well enough to price. This is not the case now, as banking supervision and regulation have become much more proactive.
What economic words of wisdom can you share for 2023?
Every year, it is good to spend some time budgeting, identifying priorities and being a bit more aware and proactive of where your money goes. And certainly, if you have not done so already, make sure you are not leaving money on the table by forgetting to sign up for valuable employer benefits or tax breaks, like matching retirement contributions, college savings programs and the like.
And I have two recommendations for the current situation. One, since interest rates are no longer zero, it pays to shop around for the best rates for savings accounts and CDs because a lot of banks pay less interest to depositors than what the Fed pays them. So, shop for rates. Second, a silver lining of higher rates is a stronger dollar. If you’ve been wanting to travel to the U.K., Europe or Japan, you will find your dollar goes a lot further now than it has in a long time.