The U.S. Economy Is Confusing Everybody

As someone paid to tell stories about the economy, I always find it satisfying to piece together data points to produce a compelling pointillist picture of the state of the world. But times are tough for economic pointillism. Data is everywhere, and the big picture is a big mess.

I look at the stock market, where valuations have crashed. Okay, the markets are trying to tell us that future growth will be slower. Then I see that consumers expect persistent inflation over the next five years. A slowdown in growth with persistent inflation? Unusual, but not unprecedented. Consumers are gloomy about economic conditions, but optimistic about their own finances, and they spend money on services, entertainment and travel as if they are enthusiastic participants in a booming economy. So everything is terrible, but i’m fine? Agree, it is psychologically rich. Nominal gas prices are at record highs, but unemployment is near multi-decade lows; mortgage interest rates are rising rapidly, but are at historically normal levels. So things are bad, but also good, but also crummy, and maybe good?

Unfortunately, there is another far more important economic storyteller who also seems deeply confused about the economy. That would be the Federal Reserve.

Just six months ago, the Fed said it expected prices to normalize in 2022, and it expected a key inflation index to rise an average of 2.6% this year. But now he expects inflation in 2022 to be twice as high, at 5.2%. Three months ago, the Fed signaled that it would raise its key rate by 0.5 percentage points in June. But this week, the Fed changed its mind after being spooked by a few inflation reports and suddenly decided to hike the federal funds rate by 0.75 points, its biggest increase in 28 years.

Fed Chairman Jerome Powell’s explanation of the rate change was disconcerting. He claimed the number of vacancies in the economy indicated “a real imbalance in wage negotiations”, but also said the labor market had virtually nothing to do with inflation. He explained that headline inflation has soared largely because of supply issues, such as the impact of the war in Ukraine on the gas market, which the Fed really can’t do anything about. But he also insisted that the Fed needed to increase the bet on interest rate hikes to lower inflation by reducing demand. He insisted he didn’t want to send the economy into recession, but the Fed’s own economic forecast predicts several consecutive years of rising unemployment, which usually only happens in a recession.

The full story barely holds together. For the Fed, inflation is partly caused by the labor market, but also not caused by the labor market; this is largely a supply-side problem that the Fed cannot solve, but the Fed is going to try desperately to solve it anyway; and we hope not to have a recession, but we will probably have a recession. As I have said: disconcerting.

What the Fed is actually trying to do here – as opposed to the story it’s telling about what’s happening in the economy – is clear, but extremely difficult: it’s trying to destroy demand just enough to reduce inflation. excessive, but not so much that the economy crashes. It’s kind of like trying to tranquilize an enraged grizzly bear with experimental drugs: maybe you’re bringing down his core temperature, but maybe you’re also leaving the big guy in a coma. The Fed could to succeed. This could cause Americans to spend a little less, borrow a little less, and lend a little less, and this synchronized decline in economic activity would almost certainly reduce inflation. But here’s the thing: if global energy prices don’t come down and global supply chains remain entangled with Omicron variants and other natural disasters, we could end up with the worst of both worlds: destroyed domestic demand and restricted global supply. Slow growth and high energy prices could mean the return of the dreaded stagflation.

Over the next few months, you should be prepared for the economic picture to get even weirder. Markets could be on the lookout for signs that the Fed is succeeding in crushing domestic demand. In other words, some investors are hoping the housing market will stagnate and retail spending will slow, as these are signs that Fed policy is working. We will be in a topsy-turvy world where bad news (economy is slowing) is interpreted as good news (Fed policy is working), and good news (consumer spending is still hot) is interpreted as bad news (the Fed’s policy is not working).

For much of this century, the Fed has been an island of relative competence in a sea of ​​institutional failures. But the Fed is neither an all-knowing artificial intelligence nor a bunch of wizarding oracles sent from the future to stabilize price levels. The people who work there are basically experts with interest rate leverage. It’s people like you and me, telling stories about an economy that they’ve recently been wrong, wrong, wrong, then a little bit right, then wrong again. I don’t know if that comforts you or terrifies you, but it’s the whole truth: right now, we’re all really confused.

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