In the past two years, many economists have predicted that the United States would face an economic recession, but it has not happened yet. On the contrary, despite facing restrictive interest rates, the US economy remains quite robust. Why do economists repeatedly make inaccurate predictions, and can the United States avoid a recession this time?
Edward Yardeni, President and Chief Investment Strategist at Yardeni Research, shared his views in an article in the Financial Times.
Yardeni believes that in the past two years, the expectation of an economic recession was logical. After all, the Federal Reserve raised interest rates 11 times from March 2022 to July 2023, significantly increasing the federal funds rate by 5.25%.
He wrote, “Clearly, such a significant tightening of monetary policy seemed likely to create problems in the financial system, triggering credit tightening and thereby leading to an economic recession. Once such a scenario occurs, the Federal Reserve will be forced to quickly lower interest rates. This has been the operating mode of most monetary policy cycles since the 1960s.”
Furthermore, there are other leading indicators signaling an imminent economic recession. For example, in the summer of 2022, the yields on 2-year and 10-year US Treasury bonds began to invert, meaning short-term rates were higher than long-term rates. This is also a precursor to past economic recessions.
However, why have many economists’ predictions gone awry? Yardeni believes there are three main reasons.
Firstly, the United States has successfully dodged the threats that have caused past economic recessions.
“Past economic recessions have predominantly been caused by credit tightening, surging oil prices, or bursting speculative bubbles,” wrote Yardeni. However, these issues did not have a significant impact on the US economy in the past two years.
“Just as in the past, the inversion of the bond yields accurately predicted this financial crisis. In March 2023, a banking crisis occurred, but it was short-lived and did not lead to a credit squeeze because the Federal Reserve responded quickly by providing emergency loans to the banking sector.”
“After the Russian invasion of Ukraine in February 2022, oil prices did surge, but ample global supply and sluggish global economic growth quickly brought oil prices back down,” he wrote, “In March of this year, the conflict in the Ha war seemed to be escalating into a regional conflict, causing oil prices to rise again, but then fall back down.”
Secondly, the resilience of the US economy has exceeded economists’ expectations.
“This is mainly because consumer spending has continued to grow,” Yardeni pointed out. The increase in interest rates on bank deposits and money market funds benefited many households. Many people also refinanced their mortgages at record low rates in 2020 and 2021.
The third and most important point is that the baby boomer generation entering retirement holds a significant amount of assets, stimulating consumption.
Yardeni noted that the baby boomers’ net assets have reached a record $76 trillion.
“They are increasing their spending on dining, cruises, travel, and healthcare, which has expanded employment in these service industries, thereby increasing real income and stimulating further consumption,” he wrote.
He also listed other factors in his article, including the effects of tightening monetary policy being offset by fiscal stimulus policies such as the massive government spending on infrastructure, incentives for onshoring (bringing back outsourced jobs to the US), and more.
Additionally, as the interest costs on US federal debt reach historic highs, Americans’ interest income from purchasing bonds has hit records.
Companies still have healthy cash flows, with many having engaged in financing and refinancing when borrowing costs were low in 2020 and 2021. Productivity growth rebounded last year and is expected to remain strong.
Yardeni also pointed out that leading economic indicators are not very effective in predicting today’s economic outlook because they do not adequately weigh the service sector, which has been consistently strong in the United States.