Third, the current economic expansion is particularly vulnerable to a sudden halt. In the near term, growth in the wage bill, economic reopening and healthy balance sheets (supported by the large fiscal stimulus measures in 2020 and 2021) should support demand, which in several sectors exceeds supply. For example, the two-year cumulative supply shortage in the automotive sector is likely to be in the millions of units. Therefore, it will take time and a considerable tightening of monetary policy to reduce demand and for this to fully translate into lower production of goods and services.
But at that time, the adjustment in production is likely to be abrupt, due to tight financial conditions, a restrictive fiscal policy and the depletion of household savings.
The entire US stock market fell more than 20%, mortgage rates rose more than 2%, and the dollar rose about 10% against a broad basket of foreign currencies (limiting exports American).
The Brookings Institution’s Hutchins Center estimates that fiscal policy dented annualized U.S. economic growth by more than 3 percentage points in the first three months of 2022 — a drag that is expected to persist through 2023.
As inflation outpaces wage growth, the personal savings rate has fallen from 26.6% in March 2021 to 4.4% in April, well below its long-term average. No wonder consumer confidence has fallen to levels last seen in the aftermath of the 2008 financial crisis, and Google searches for the word “recession” are hitting new highs.
Finally, economic history points to a hard landing. The Fed has never tightened enough to push the unemployment rate up 0.5 percentage points or more without triggering a recession. According to Sahm’s rule, when this trigger is hit, the next stop is a deeper recession, in which unemployment increases by at least 2 percentage points.
Much like Wile E. Coyote rushing off a cliff, the US economy has plenty of momentum but fast-vanishing support. Falling back to earth will not be a pleasant experience.
Bill Dudley is a senior fellow at Princeton University, he was president of the Federal Reserve Bank of New York and chairman of the Federal Open Market Committee.