(Bloomberg) — The inflation roller coaster of the past few years has left economists humble about their ability to predict, but the U.S. soft landing and ultimately the Federal Reserve ( The Federal Reserve is hopeful of lowering interest rates.
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At the three-day annual meeting of economic experts that concluded Sunday in San Antonio, many participants acknowledged the difficulties they faced in predicting the outlook for the global economy and inflation post-pandemic. Many people failed to predict that inflation would soar to multi-decade highs and mistakenly believed that a recession was needed to reverse inflation.
“We didn't really understand why inflation spiked in the first place,” said James Hines, a professor at the University of Michigan. “Maybe we shouldn't be surprised that it collapsed sooner than we thought.”
The decline in inflation (the Fed's preferred measure fell to 2.6% in November from a high of 7.1% in June 2022) has led economists in Texas to believe the economy is on the downside. Expectations were high that the stock would return to the Fed's 2% target without any problems.
Professor Emi Nakamura of the University of California, Berkeley, said, “It's difficult to predict the turning point, so I think we should respond with humility.'' But “at this point it's pretty reasonable.”
That would be good news for President Joe Biden. He has seen his poll numbers slump amid voter anxiety over rising costs of living, and faces even greater headwinds to his re-election in November if the U.S. slips into recession. It will be.
Economists attending the American Economic Association meeting said lower price pressures should allow the Fed to cut interest rates, but perhaps not as quickly as investors hope.
Traders in the federal funds futures market expect the Fed's first rate cut to occur in March, bringing rates down to around 4% by the end of the year. The Fed currently has a target range for funds rates of 5.25% to 5.5%.
interest rate cut
“Without a doubt, they will cut rates this year,” Ellen Zentner, Morgan Stanley's chief U.S. economist, said at the conference. But “they can be patient and take their time.” He expects the Fed's first rate cut will be in June.
John Taylor, a professor at Stanford University who has been harshly critical of the Fed's initial slowness in tightening credit, said the Fed has not been far behind in combating inflation since the sharp rate hike starting in March 2022.
If inflation continues to fall, “interest rates will go down,” Taylor said. The economic rules that bear that name are used by central banks to guide monetary policy. He suggested interest rates could eventually fall to 3-4%.
That doesn't mean everything is going smoothly. Chief among the risks is a geopolitical shock, an escalation of war in the Middle East that would cause oil prices to soar.
Ricardo Reis of the London School of Economics said that would undermine still-fragile inflation expectations and risk a repeat of the inflation spiral and subsequent deep recession seen in the 1970s. did.
“I think we're very close to having a permanent problem,” he says. But he said the chances of that happening were slim and otherwise believed inflation would return to 2% by the end of the year.
Dependency on model
In a postmortem of what economists got wrong last year, Northwestern University professor Janice Eberly says the profession relies too much on computer models built on past economic relationships. stated at the meeting. These people suggested that a recession was necessary to overcome the inflationary backlash, as occurred in the 1970s.
“We should never have trusted our models,” especially after a once-in-a-century pandemic, said a former U.S. Treasury official, who at the time suspected the models were too pessimistic. He added that he had done so. “The model is a radical simplification.”
In a paper presented to the conference, Columbia University's Martin Uribe wrote that by extending the model's time horizon to before World War II, a time when spikes in inflation were more common and pandemics occurred earlier. proposed.
A major reason the United States has been able to avoid a recession is the expansion of the so-called supply side of the economy. That's partly because prices for cars and other goods have risen sharply as supply chain disruptions caused by the pandemic have eased.
Those pressures “were not temporary. They were persistent,” Eberle said, recalling discussions at the beginning of the 2021 inflation surge about how long it would last. “But they weren't permanent.”
Even more surprising to economists was the sharp rise in the number of workers, especially due to increased labor force participation and increased immigration.
“The supply side of the economy has come back in a much more supportive way than most people expected,” Eberly said. “That's the most promising part of a soft landing because it means we can maintain strong growth without putting upward pressure on inflation.”
–With assistance from Catalina Saraiva.
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