A perplexing economy
Economists around the country, including those at the Federal Reserve, have admittedly been perplexed when it comes to predicting the national economy’s direction. Phil Powell, associate dean of Kelley academic programs at Indianapolis and academic director of the Indiana Business Research Center said:
“The economy’s recovery was thrown off track when the ‘transitory’ inflation of 2021 became persistent, and the Federal Reserve belatedly began to raise interest rates. The result has been the most uncertain outlook in a half century.”
Weak output growth at best. Will consumption hold up?
According to researchers, output growth will be weak in 2023 at best, with a strong possibility of negative growth for at least part of the year. Consumer demand will begin to diminish next year, which is key to the economic outlook. If consumption holds up and consumers continue to spend money, it will cushion any decline. If not, a recession will be unavoidable.
There has been a split in consumer spending between goods and services. The lockdown in the second quarter of 2020 led to a 10% drop in total consumption, but most of it was a decline in services. Spending on consumer goods was hardly affected. This trend has continued to the present. In the third quarter of 2022, goods consumption is 15.2% higher than its pre-pandemic level, while services are up just 3.4%.
The Kelley forecast also noted the relationship between total consumption and the level of household after-tax income. In 2020 and 2021, government COVID-19 payments greatly increased income relative to consumption, producing a rise in household saving. The savings rate averaged 8.8% in 2019, rose above 20 percent early in 2021, and then receded.
And what about that labor shortage?
There is also concern about the drop in the labor force participation rate — the percentage of those over age 16 who are working or actively looking for employment. Over the past year, the economy has added jobs at a rate of 440,000 a month and unemployment has fallen to 3.7%. At the same time, workers have left the labor force, leaving the national labor force participation rate below its pre-pandemic level by 1.2%.
“That may not sound like much, but it amounts to over 3 million ‘missing’ workers. The participation rate shows no signs of imminent increase. With unemployment close to a historic low, we have an economy that faces a systemic shortage of labor.”
Other risks to the forecast include the international impact of the continuing war in Ukraine, how central banks in developed countries handle their fiscal policies and tightening financial conditions as interest rates rise.
Other key points from the forecast
Other key points from the forecast:
- The stock market has lost $10 trillion over the past year. The Kelley panel believes that most of the losses are behind us, but there is a reasonable chance that losses may continue.
- Seventy percent of S&P 500 companies have reported earnings above what Wall Street expected. Their future earnings are expected to rise by 2.2% next year.
- Interest rates have risen and will go higher because of Federal Reserve actions. The federal funds rates are expected to top out somewhere between 5 and 5.5% by summer.
- Short-term and medium-term interest rates will remain higher than long-term rates until inflation is reduced to target levels.
- 2023 inflation should appear lower than 2022, which is a function of year-over-year comparisons shifting with the calendar.
- The starting point for the forecast is an econometric model of the United States, developed by IU’s Center for Econometric Model Research, which analyzes numerous statistics to develop a national forecast for the coming year. A similar econometric model of Indiana provides a corresponding forecast for the state economy based on the national forecast plus data specific to Indiana.
About the Indiana Business Review report
A detailed report on the outlook for 2023 will be published in the winter issue of the Indiana Business Review, available online in December. In addition to predictions about the nation, state and Indianapolis, it also will include forecasts for other Indiana cities and key economic sectors.
The Kelley School presented its forecast today on the campus of Ivy Tech State College in Bloomington. Kelley faculty will present their forecast in eight other cities around the state, where they will be joined by local panelists from other IU campuses and other universities, offering perspectives on the global, national, state and local economies as well as the financial markets. The tour is sponsored by the Kelley School of Business and its Indiana Business Research Center, the IU Alumni Association, IU campuses and numerous community organizations.
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