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The Federal Reserve’s mission to combat inflation by raising interest rates is likely to tip the economy into a mild and short recession sometime next year. The continuing high price of gasoline and energy in general because of the Ukraine war, and the continuing shortage of houses, cars and workers will also keep prices and wage rates high in general. That means interest rate hikes are likely to be large and persistent until the Fed observes a measurable slowdown in the economy, at least. Long-term interest rates will stay up as long as inflation does, also until the economy slows noticeably.
Besides the Fed, other forces will lead to an economic slowdown: Consumers will start to be more cautious in their spending because of recession fears, besides the normal cutting back in the face of higher prices. Businesses will likely delay buying equipment for expansion and trim their hiring plans as Meta (Facebook) and Tesla have already started doing. Slowing growth in Europe plus the strong rise in the value of the U.S. dollar will make the trade deficit problem worse.
But there are positives as well: Consumers have $2.75 trillion in excess savings built up during the past two years, and will spend on services such as entertainment and travel that many have skipped during the pandemic. The slowing economy will take the edge off the shortage of workers and the overheated housing and motor vehicle markets, which could be good for bringing inflation under control. Workers are not being laid off at the moment, with initial unemployment claims still at low levels. (Recessions generally require the unemployment rate to rise.) The shipping crunch that added costs to imports is slowly being resolved.
On balance, GDP growth will likely slow to 1.8% in 2022, and slow further to less than 1% in 2023. This allows for two quarters of mild contraction next year. The economy did contract 1.6% in the first quarter of 2022, but this was a small reversion after the strong previous quarter’s growth of 6.9%.
Source: Department of Commerce: GDP Data
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