Savannah Chamber

7 1 The National Outlook By Jeffrey M. Humphreys, Terry College of Business, University of Georgia www.selig.uga.edu The Terry College's 2023 baseline forecast for the US economy calls for a mild recession in 2023. The probability of recession is 75 percent. High inflation leaves little room for a soft landing. A 2023 recession is not inevitable, but near perfect monetary policy moves and a bit of luck will be needed. Even if the Federal Reserve manages to achieve a soft landing, the economy is likely to grow slowly, or pause in 2023. The Federal Reserve's 2022 shift in monetary policy from an accommodative to restrictive to combat high inflation is the primary reason why we expect a recession in 2023. The policy pivot is aggressive. Large increases in policy interest rates coupled with reductions in the Federal Reserve's balance sheet are designed to reduce demand to bring down the highest inflation in 40 years. One goal is to cool down the labor market to prevent a wage-price spiral from becoming more entrenched. That will be hard to do without pushing up the unemployment rate fast enough to cause a recession. The bond market agrees. In mid-2022, the spread between the 10-year and 2-year treasury yields inverted, suggesting that market participants believe that the Federal Reserve will tighten too much to avoid recession. There are many factors behind the recent surge in inflation, including supply chain problems, energy price shocks, less favorable demographic trends, less foreign immigration, the recent retreat from globalization, the lagged effects of unprecedented fiscal stimulus, more regulation, and the rapid growth of the money supply – quantitative easing – that occurred during the pandemic. Demand-side drivers of inflation will respond to higher interest rates and quantitative tightening. For example, housing is in recession and investment spending is cooling. Quantitative tightening – reducing the money supply – will help, too. The supply-side drivers of inflation will not be responsive to a more restrictive monetary policy. Indeed, higher interest rates will worsen some supply side problems by restraining investment in new production capacity. Nonetheless, inflation will drop, but not to the low levels experienced prior to the pandemic-recession. Over the next decade, we believe inflation will average about 3 percent per year compared to 2 percent per year prior to the pandemic. We believe the Federal Reserve eventually will raise its inflation target to 3 percent from 2 percent. On Main Street, the doubling of mortgage rates was the first tangible evidence of the shift from easy to tight money. Higher mortgage rates combined with the recent sharp run up in home prices dramatically reduced housing affordability, which quickly pushed the US housing industry into recession. Russia's invasion of Ukraine pushed up energy and commodity prices and decreased confidence. The economy paused in the first half of 2022, but a retreat in oil prices and the strong labor market prevented the US economy from lapsing into recession immediately. In the second half of 2022, policy interest rates moved firmly into restrictive territory and began to more broadly impact labor markets and the overall economy. Measures of business and consumer confidence demonstrated a gradual loss of faith in the economic situation. Unless reversed, decreased sentiment can be fatal to an economic expansion. Inflation-adjusted consumer spending trended nearly flat, but the labor market proved resilient. In 2022, the strong US labor market held off a recession. For example, mid-year unemployment rates fell to lows rarely experienced in the last half century. Indeed, record low unemployment rates were reported by many states, including Georgia. Employers were understandably slow to lay off workers even

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