Federal Reserve economists have the right idea. Having been burned by poor forecasts when inflation was below 2% during Janet Yellen’s tenure as chair and when price increases accelerated as COVID shutdowns ended, in November they pegged the likelihood of a recession near 50%—a coin toss.

Financial markets are flashing warning signals, but the consensus among business economists is for a modest deceleration. The average forecast for 2023 gross domestic product growth is 0.3% with unemployment and inflation around 4.1%.

Uncertainties

Given the economics profession’s fixation with the uncertain lags for the impacts of monetary policy on inflation and unemployment and the Fed’s obsession with household and market expectations and misplaced confidence in the efficacy of its tools, we can expect the pace of interest-rate increases to slow and end this year.

Fed Chairman Jerome Powell may fall victim to Arthur Burns’ mistakes in the 1970s when the Fed eased tightening too soon and inflation eventually reached double digits.

Powell faces terrible uncertainties, and the current situation illustrates what tech folks call “emergent behavior” risk. That’s when complex, interrelated systems spin into disaster owing to the mistakes of one player or an isolated accident. One counterparty failure allegedly setting off the Lehman Brothers’ collapse or a tree branch falling on a power line in Ohio creating blackouts in Michigan, New York and Canada.

China Questions

No one can know whether China will exit Zero COVID without imploding, Ukraine can survive a winter of Russian missiles crippling its electrical grid, or high U.S. interest rates will drive developing country governments into default.

The violence at the Foxconn facilities manufacturing iPhones, broader civil unrest in China, and potential consequences for Western supply chains could impose a deeper recession on the global economy.

Those shouldn’t be modeled into baseline forecasts, but all could make 2023 and 2024 at lot worse.

In contrast, President Xi Jinping could find a path to reopen China without a dystopian epidemic, Russian retreats could turn into a rout at the hands of the Ukrainian military, and diversification of supply chains away from China could give key developing economies a lift.

Whatever happens, the United States will be forced to do business with unsavory regimes to unlock enough oil, but refinery capacity limitations will constrain supplies. The labor market won’t get too easy for employers anytime soon, and the country faces a long-term shortage of housing.

Era of 5% Interest Rates

Near-term inflationary pressures from energy, wages and rents may abate, but pushing inflation below 4% will prove tough. To keep it from spiraling up again, the Fed may have to keep the federal funds rate FF00, +0.00% near or above 5% for several years—about double what the dot-plot indicates.

However unpleasant, we endured similar inflation for several years after Paul Volcker slew his dragon in the early 1980s. And the U.S. economy is on the cusp of a more dynamic period reminiscent of the New Economy of the 1990s.

Big layoffs in the tech sector are likely more permanent at what I call the non-tech techies—businesses that grew large by exploiting network effects on optimal scale—like Amazon’s e-commerce business, Meta, Twitter and Uber. But job losses among innovators like Intel, Microsoft, Alphabet and Apple—businesses that create the machinery and foundational software for the internet, virtualization, automation and broader digital economy—will be more in tune with a mild recession.

Beyond the tech sector, employers are still adding jobs.

Massive Realignment

The build-out of artificial intelligence and robots, improvements in distance-working technologies, the spread of populations away from land- and tax-expensive cities like New York, electric vehicles and charging stations, less expensive alternatives to college and an upgrade in the technologies supporting local government will require massive amounts of new capital and impose radical changes.

Higher education will no longer be the default option for high school graduates seeking high-income careers. Core cities will have to find ways to repurpose commercial facilities to housing or face decline, and some college campuses will confront a fate similar to abandoned shopping malls.

This time around the cost of capital won’t be zero, but 5% or 6% interest rates with 4% inflation will make raising the needed funds still doable.

Investments will be more disciplined and better support productivity growth and broadly rising living standards for folks who invest wisely in skills.

The devices and software created by Google, Apple, Zoom and others will stimulate new growth.

Having to first endure a recession, President Joe Biden may not reap the political benefits of the dynamism about to uncoil, but four years from now we will feel better no matter who is in the White House.

To borrow from President Ronald Reagan’s reelection campaign, it will be “Morning Again in America.”
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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.