Erica Groshen

Visiting Senior Scholar at the School of Industrial and Labor Relations

“One big question for the months ahead: Will holiday spending be muted by higher inflation and/or the economy slipping into recession? A large share of annual economic activity takes place during the Thanksgiving to New Year’s holiday season. All recessions are unique, but this one – if it is one – will be particularly difficult to model with any certainty.

“The labor market is very strong, fiscal policy has been very supportive (albeit waning as we enter the slowdown), monetary tightening has been aggressive, the war in Ukraine adds to uncertainty, and the pandemic’s path is unknown. Business cycle turning points are characterized by conflicting signals, and this one is likely to be more confusing than most.

“The Fed means to convey its intention to return the economy to price stability without triggering a deep recession. Interest rates are just now approaching levels that are considered high historically, after a series of sharp federal funds rate increases and ongoing balance sheet reductions. Assuming that the Fed increases the federal funds rate by another 75 basis points – as it has already signaled it will – the attention will be mostly focused on the statement and what that implies for the economic outlook.

“There are four scenarios to consider for the short to medium term:

1. Strong rebound with overheating: Inflation and economic activity picks up, so the Fed has to act more strongly in the coming months. This is unlikely as we see slowing in real estate, housing, and some parts of manufacturing. But with the persistence of inflation and strong labor market indicators, it cannot be ruled out entirely.
2. Soft landing (what the Fed and we all hope for): Activity slows for an extended period – up to a quarter – but GDP losses are small. Inflation also subsides. Plausibility is aided by a strong labor market, high savings, and remaining fiscal stimulus. Real wage growth and continued employment for the most liquidity constrained consumers helps to sustain holiday spending, aiding in preventing a recession.
3. Mild to moderate recession: 2-3 quarters of declining GDP and subsiding inflation. Entry to a recession begins in earnest during the holiday season. Lags in the impact of monetary policy and ongoing uncertainties combine to restrain consumption and investment enough to trigger a recessionary dynamic.
4. Spiral into deep recession: 4+ quarters of declining GDP followed by slow recovery. Monetary policy, bad shocks, and high uncertainty combine to seriously undermine confidence by consumers and businesses, triggering high layoffs and a rapid downward spiral.”