Economic Outlook | Fall 2022

Think of the Federal Reserve Board (FRB) as the responsible one at a party for young adults. Their job is to take away the punch bowl, just as the party is really getting started. It’s not that they don’t like a good party, but it’s their job to prevent a hangover the next morning. In this analogy the FRB spikes the punch bowl with low interest rates or quantitative easing to bring life to the economy. In September 2001 they added Vodka, in 2008 they added tequila, in 2020 they figured Bourbon was a good fit. Now the punch bowl has been taken away and many economists fear it’s a little too late.

Congress has given the FRB a dual mandate of price stability and maximum employment. The employment picture is pretty good. According to FRB Chairman Powell, “The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers.”* Inflation, however, as measured by the consumer price index, hit 9.1% this summer. The FRB is tackling inflation; taking away the punch bowl. It now appears that inflation is not transitory, as previously thought. This means that after a series of rate hikes, the chairman will likely need to keep rates higher for longer than previously thought. “Restoring price stability will likely require maintaining a restrictive policy stance for some time.”*

While some believe we can kill inflation and avoid a hangover (the press calls this a soft landing), odds of avoiding a recession are diminishing. In the words of Chairman Powell, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.”*. Corporate America is already beginning to see the warning signs of an economic slowdown. “A total of 240 companies in the S&P 500 mentioned recession on their post earnings conference calls for the last quarter, the most ever in FactSet’s data going back to 2010.”^.

On the brighter side, we should consider consumer’s expectations of inflation. As Chairman Powell puts it, “If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation.”*. Good news on that front. According to the Federal Reserve Bank of New York, “…households see inflation at 5.7%, down from the 6.2% they predicted in the July survey. Three years from now survey respondents expect to see inflation at 2.8%, down from the 3.2% seen in July…. Five years from now, survey respondents see inflation at 2% as of August, down from the July’s 2.3% forecast.”#

Inflation is a beast we have tamed before, and the FRB seems committed to controlling it now. There are also structural, long term deflationary trends working in the Fed’s favor, primarily demographics and technology. Time will tell if the FRB is successful, but for now, there is reason to be optimistic.

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* Reassessing Constraints on the Economy and Policy, August 26, 2022

^Wall Street Journal 9/13/22 “Weaker Earnings Forecasts Test Rise in Stocks”.

# Wall Street Journal 9/13/2022 “Inflation Expectations Declined in August”