It is not the first time that the sharp rise in interest rates in the previous two years has prompted warnings from an economist about the outlook for the business cycle.
However, the forecast still resonates when it comes from a Nobel laureate, even after the latest optimistic economic news from the United States.
The biggest near-term risk is that “the central bank raised interest rates too much, too quickly,” Joseph Stiglitz explained at a conference hosted by the Japan Society in New York on Wednesday (February 7).
Speaking at the group’s Global Risk Forum, he said the Federal Reserve “misdiagnosed” rising inflation in 2021-2022, prompting sharp increases in interest rates to control price pressure.
Although there are signs that policy tightening is succeeding as a contributing factor to the recent bout of disinflation with limited consequences for growth, the Columbia University economics professor still sees the potential for problems ahead. .
Stiglitz said the Federal Reserve viewed inflation as a demand-side problem, but the economist told the audience it was primarily a supply-side problem.
As an example, he warned that a key factor in the increase in inflation in the current cycle has been the increase in housing prices, which accounted for approximately a third of the increase in prices.
A crucial part of the solution, he added, was that the economy needed more housing to help drive down prices.
Instead, by dramatically raising interest rates and, by extension, mortgage rates, an aggressive shift in monetary policy created obstacles to increasing residential housing construction.
In fact, home construction has declined substantially since monetary policy became restrictive in March 2022, as shown in the chart below.
New privately owned housing units
Stiglitz added that while the U.S. economy “will do quite well” compared to the rest of the world overall, sharply rising interest rates will remain “a threat to growth in 2024.”
He cites the “long and variable impact” of monetary policy as a persistent obstacle, noting that policy changes can take time to fully impact the economy, for better or worse.
Stiglitz’s good faith in the dismal science is reason enough to refrain from dismissing his warning, but for now the US economic profile continues to defy the darkest forecasts from various corners over the past year.
Yesterday’s estimate of US GDP for the first quarter via the Atlanta Federal Reserve’s GDPNow model (as of February 7), for example, reflects a solid increase in expected output that is in line with the greater than expected increase in the fourth quarter reported by the government.
Meanwhile, CapitalSpectator.com’s sister publication, The US Business Cycle Risk Report, continues to estimate the probability that an NBER-defined recession has begun or is imminent at a minimum of 1% (as of February 2), based on the probability of compound recession. Indicator, which combines estimates from several models.
CRPI probit model estimates
Looking beyond the immediate future when making high-confidence forecasts is extremely challenging for business cycle analysis, so caution is advised on this front.
However, Stiglitz’s warning is not easily dismissed. But if we give up forecasts, the current figures clearly suggest that the risk of recession is low, a profile that even a Nobel Prize-winning economist would find difficult to refute, at least for now.