You Decide: Will 2023 be naughty or nice?

Published 8:09 am Saturday, December 31, 2022

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By Mike Walden

The traditional holiday question to children, “Have you been naughty or nice,” is a perfect lead-in to the economic outlook in 2023. As 2022 ends and 2023 begins, we face two economic challenges: inflation and recession. The big questions are, will inflation return to normal in 2023, and will it take a recession to do so?

Actually, we’ve already seen some progress on inflation. Year-over-year inflation was over 9% in the summer, but recently it’s been under 8%. That doesn’t seem like much, but at least the rise in prices has been slowing.

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But the decline in the price of gas at the pump has certainly brought smiles to our faces. After the national price per gallon jumped to over $5 in June, we’re now seeing gas prices in the low $3 range.

Interest rates are another matter. If you’re borrowing money for a home, vehicle or another big-ticket item, you’re now paying more than twice as much as a year ago. For example, despite some slippage in November and December, 30-year fixed mortgage rates are still hovering near 6.5%. At the end of 2021, they were under 3%.

The bottom line is that most people are still struggling economically as we end one year and move on to another. Even if a person received a pay boost in 2022, it was likely less than the increase in prices they paid. If your income rises less than prices, then your standard of living has dropped.

2022 has been a rough year. Will it get any better in 2023?

Part of the reason for inflation has been problems with businesses getting enough supply of the products we want to purchase. The pandemic gave us a new term for this situation: supply chain problems. When we are trying to buy things, but there are not enough of those things to buy, then the prices of those things jump.

The good news is that supply chain problems have eased. One measure shows the intensity of supply problems improving 75% since 2021. As a result, sellers have more inventories, and delivery times have returned to pre-pandemic levels. The improvement in the supply chain should help moderate inflation.

But will it be enough? The Federal Reserve doesn’t think so. The Federal Reserve — commonly called “the Fed” — is the nation’s central bank. It has the ability to create money, and it uses that power to nudge interest rates up and down. If the Fed wants to stimulate borrowing and spending, it lowers interest rates. It did this at the height of the pandemic, which, among other things, created massive home buying. But if the Fed wants to moderate borrowing and spending, it pushes interest rates higher.

In the Fed’s view, we are trying to spend more than the economy can provide. This puts upward pressure on prices, meaning the inflation rate jumps. Even though the supply chain is improving, the Fed still thinks consumer spending is running too hot.

But part of today’s problem is a result of the Fed. When the pandemic was raging, the Fed’s key interest rate was zero. This was designed to boost spending. The Fed has now raised its key rate to nearly 4%, and most economists think the rate will go higher. The Fed will watch the pace of the economy to guide them on interest rate policy.

Of course, the Fed doesn’t want to create a recession where sales fall and unemployment rises. Unfortunately, one of the best predictors of a recession — a measure called the “inverted yield curve” — is giving its strongest forecast of an upcoming recession in 40 years.

Thus, I — and many economists — are forecasting a recession for some period in 2023. The good news is that it will likely be relatively mild. The unemployment rate, currently under 4%, could rise to 5% or 6%. An unemployment rate in that range is historically low for a recession. Still, with a jobless rate of 5% or 6%, between 50,000 and 100,000 workers in North Carolina would be added to the unemployment rolls.

Although North Carolina’s economy has been growing faster than most states, North Carolina will feel a recession. Even North Carolina’s rapidly expanding cities and metropolitan areas will know a recession has arrived. In fact, if history is any guide, metro regions could suffer more. For example, in the so-called “subprime” recession of 2007-2009, the economies in metropolitan North Carolina contracted by a larger percentage than the economies in rural regions.

If a recession does happen in 2023, look for businesses in sectors selling products or services that can be postponed to be hit harder. These are sectors like real estate, construction, manufacturing, retail and leisure/hospitality. Businesses selling necessities like food, health care, education and energy will be less negatively impacted.

When will the economy get better? When will we have inflation under control and the economy growing again? I’m hoping we will see these conditions toward the end of 2023. By then, I think we could see the inflation rate half of what it is today, thereby allowing the Fed to ease up on the brake and slightly push down on the gas pedal for the economy. That is, I think the Fed could be reducing interest rates and stimulating the economy a year from now. A year from now, we could see the 2023 recession end and a new economic expansion beginning.

So, I see challenges but then relief for us and the economy in 2023. I wish I could be more upbeat, but my intent is to be honest and clear. Is my forecast helpful? You decide.

Dr. Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.