Recent readings on U.S. economic activity present a puzzlement. Although the Federal Reserve has hammered the interest rate lever 10 times since March 2022, the economy is still sailing along as if it has a mind of its own, at least by some popular measures.
The latest reading on retail sales indicates that consumers have not cut back on their spending and that auto sales and travel are surging. We already knew January employment rose by 517,000 jobs and that the unemployment rate was in the cellar at 3.4%.
NOW IS THE TIME TO CAPITALIZE ON INTEREST RATE HIKES
Yes, interest rate-sensitive activities such as housing starts and sales are headed south, but other parts of the economy seem unfazed by the Fed. When the national data don’t provide easy answers, it sometimes helps to look at the individual states.
Here’s another way to view the question: For months, some have said the Fed’s interest rate run-up will bring down inflation as intended — along with the economy. This “hard landing” would mean a recession before year-end. Other, more optimistic souls expect a soft landing — one in which the Fed’s monetary elixir works almost magically, with inflation falling toward 2% by year-end while the economy avoids tipping into a recession.
Both the hard and soft landers are on the lookout for diminished hiring, a higher unemployment rate, and improved inflation readings. But since those readings are not forthcoming, we now have a third set of voices calling for no landing at all. The “no landing” crowd expects to see continued growth alongside ongoing inflation that, while perhaps somewhat diminished, is still built into the economy. They say, “Get used to it.”
Which will it be? Hard, soft, or no landing at all?
We need to look at other evidence of a Fed-affected economy. First, as stated here before, we should not forget money supply growth, which turned negative, year over year, in November 2022 and predicts a very slow economy about a year from now. Then there are job openings, which, like daffodils in early spring, we might consider as the first sign that employment will grow or shrink. Year-over-year growth for job openings turned negative in September and remains so. Or maybe it’s new hires, wherein growth went negative last June and has stayed in the cellar.
But even more informative, perhaps, is what’s happening with state economic indicators. If a recession is in the works, it will not show up everywhere at the same time.
A series of maps prepared by the Federal Reserve Bank of Philadelphia shows three-month growth for coincident indicators — what’s happening now, more or less — for the 50 states. These indicators are built using labor market data that include unemployment, wages, and hours worked in manufacturing.
In June, just one state, Montana, was moving in a negative direction. As of the newly released December reading, the most recent data available, 13 states spread across roughly the northern half of the country are now negative (Montana has turned positive). Prior to that, from December 2021 through May 2022, not a single state was negative.
What might we conclude from all this? Negative money supply growth and negative state economic indicators are signaling that the Fed’s slowing efforts are having an effect that will grow stronger across the next 12 months. Unless the Fed takes the brakes off money supply growth, I still expect to see a hard landing near the end of 2023, along with a meaningful reduction in inflation, instead of a more pleasant soft landing or no landing at all.
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Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University, a dean emeritus of the Clemson College of Business and Behavioral Sciences, and a former executive director of the Federal Trade Commission.
