Although many say the economic outlook for next year appears bleak, there is room for optimism.
By Dr. D. Brian Blank
Assistant Professor of Finance
Mississippi State University
By Dr. Rodney Ramcharan
Professor of Finance and Business Economics
University of Southern California
Introduction
Are we headed for a recession in 2023?
Brian Blank: The consensus view among most forecasters is that there is a recession coming at some point, maybe in the middle of next year. I’m a little bit more optimistic than that consensus.
People have been calling for a recession for months now, and this seems to be the most anticipated recession on record. I think that it could still be a ways off. Consumer balance sheets are still relatively strong, stronger than we’ve seen them for most periods.
I think that the labor market is going to remain hotter than people have expected. Right now, over the last eight months, the labor market has added more jobs than anticipated, which is one of the strongest streaks on record. And I think that until consumer balance sheets weaken considerably, we can expect consumer spending, which is the largest part of the economy, to continue to grow quickly.
[But this] doesn’t mean that a recession is not coming. There’s always a recession somewhere down the road.
Rodney Ramcharan: Indeed, yes, there’s a likelihood that the economy is going to contract in the next nine months. The president of the New York Fed expects the unemployment rate to go up from 3.5% currently to somewhere between 4% to 5% in the next year. And I think that will be consistent with a recession.
In terms of how much worse it can be beyond that, it’s going to depend on a number of things. It could depend on whether the Fed is going to accept a higher inflation rate over the medium term or whether it’s really committed to getting the inflation rate down to the 2% rate. So I think that’s the trade-off.
Will unemployment go up?
Blank: [Unemployment] hasn’t risen much, and maybe it’ll pick up to somewhere close to 4%. Many are expecting something like four and a half percent. And I think that’s certainly possible. And I think that we can see small upticks in the coming months.
But I don’t think it’s going to rise as quickly as some people are expecting, in part because what we’ve seen so far is a lack of labor force participation. Until more people enter the labor market, I think there are going to be plenty of jobs to go around.
What is your outlook on interest rates?
Ramcharan: As people find it more and more difficult to find jobs, or to get jobs as they begin to lose jobs, I think that’s going to dampen spending. And we’re seeing that now as the cost of borrowing has gone up sharply, and the Fed is expecting that.
The expectation is the federal funds rate will go up to 5% by next year. If you tack on another couple of points, because of the risk involved, then the cost to borrow to buy a home could potentially get up to 8% for some people. And that could be very expensive.
And the flip side of this for businesses is there’s potentially going to be a slowdown in cash flow. If consumers are not spending, then the revenues that businesses depend on to make investments might not be there.
The additional piece in this puzzle is what the banks will then do. I think banks are going to begin to curtail the extension of credit. So not only will interest rates go up for the typical consumer and the typical business, it’s also likely that they are more likely to experience denial of credit, and so that should together begin to slow spending quite a bit.
After massive increases in housing prices, what caused them to suddenly drop?
Ramcharan: As the Fed lowered interest rates, there was a massive shift among the population for various reasons. They decided that housing was the right investment or the right thing. And so when 50 million people all collectively decide to buy homes, the supply of homes is reasonably constrained in the short run. And so that led to this massive increase in house prices and in rents.
In the last three months, the housing market has cooled sharply. We’re now seeing house prices beginning to fall. I would imagine, going forward, the housing market cooling is going to be a major driver behind the slowdown in the inflation rate and in real estate investment trusts. So that’s positive.
Our recent election just changed the composition of Congress. How will that affect the economy?
Blank: Certainly, when we have a divided Congress, we’re less likely to see decisions made that involve passing legislation that might support the economy. And I think it’s likely the Republican House is going to become a little bit more conservative with spending.
And so if we do start to see a downturn, I think you’re less likely to see legislation that might help support an economy that could be in need of it. That is going to make the job of the Federal Reserve more important.
How certain are these predictions?
Ramcharan: I just want to be careful here and let your viewers know that we’re making these statements based on theory, because the inflation that we’re experiencing now comes about from a pandemic, and there really is no evidence, there’s no data available, that people can look to to say, “What happens to an economy after a pandemic?” That data does not exist.
So we’re trying to piece together the data we do have with the theories we do have, but there’s a huge band of uncertainty about what’s going to happen.
Originally published by The Conversation, 12.19.2022, under the terms of a Creative Commons Attribution/No derivatives license.
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