Connect with us

Hi, what are you looking for?

Trillions - 19FortyFive

The U.S. Economy Is Still in Big Trouble

U.S. Economy
Image of US Currency. Image Credit: Creative Commons.

Hope springs eternal. Today’s stronger-than-expected GDP numbers are bound to be trumpeted by optimists that the U.S. economy can achieve a soft economic landing.

Before being carried away by that optimism, one might want to place today’s GDP numbers in the context of the two-quarters of negative economic growth that preceded it. More importantly, one might want to take note that these numbers are likely to encourage the Federal Reserve to continue with its excessively hawkish monetary policy stance. That continued hawkishness all too likely will lead to a hard economic landing.

To be sure, we must welcome today’s better-than-expected GDP number. However, if we take into account that the third quarter’s 2.6 percent GDP number was preceded by two consecutive quarters of negative economic growth, we have to conclude that the US economy has basically been flat this year. That is hardly anything to write home about particularly when all the inflation indicators are pointing to inflation still running at multi-decade highs. Nor is it anything to write home about when the underlying strength of demand seems to be fading.

A basic problem with today’s Federal Reserve is that it is very much a data driven institution that overlooks the fact that monetary policy operates with long and variable lags. This induces it to look more in the rear-view mirror than to look at what might lie ahead. Rather than wait to see the effects of its unusually rapid pace of monetary policy tightening it has already taken this year, the Powell Fed plans to keep raising interest rates at a rapid clip until it sees clear signs that inflation is abating in a meaningful manner.

When it meets next week, the Fed is likely to view today’s stronger-than-expected GDP number and still uncomfortably high inflation as yet another reason to continue raising interest rates aggressively. This is likely to induce the Fed to raise interest rates for a fourth time this year by an unusually large 75 basis points. It is also likely to cause the Fed to intimate that there will be further interest rate increases down the road. Never mind that this is the fastest pace of Fed interest rate increases in any post-war tightening cycle.

Among the reasons to fear that the Fed’s hawkishness will lead to a hard economic landing is that it has caused mortgage rates to more than double from around 3 percent at the start of the year to around 7 percent at present. That has made housing ever less affordable. If someone could afford a $400,000 home at the start of the year, they can now only afford to buy a house worth around $300,000.

Typically, US economic recessions have been led by housing market declines. Judging by the recent slew of weak housing numbers, it would seem that this time around will be no different. Not only are mortgage applications and housing starts plunging. Home builder confidence is at an all-time low and home prices have now started to decline.

Another reason to fear that the Fed’s hawkishness will lead to a hard landing is that it has caused the dollar to surge by 15 percent to a 25-year high. This is bound to deal a body blow to our export sector, encourage an import surge, and complicate an already difficult world economic outlook.

Having been asleep at the wheel in 2021 and having allowed inflation to surge to a multi-decade high, the Fed is now determined to slay the inflation dragon at all costs to restore its price stability credibility. However, in the process the Fed is likely to plunge the economy into a deep recession. That will likely lead to its failure to deliver on the high employment part of its dual price stability and high employment mandate after first having failed to deliver price stability.

In which case, the Fed should brace itself for real political heat next year.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

Written By

Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and multilateral lending agencies.

Advertisement