Will the inflation rate rise again or continue to fall? Will the Federal Reserve raise or lower rates? Dr. Michael Walden, an economics professor at NC State University, answered these questions during his recent 2024 Economic Forecast presentation to the Cary Chamber of Commerce. What follows is a summary of his remarks.
Getting Back to Normal in 2023
Dr. Walden characterized 2023 as a continuing recovery from the pandemic, as many economic indicators returned to normal levels. The year ended with the total number of jobs above pre-pandemic levels. GDP growth settled back into the range where it had been pre-pandemic, and the unemployment rate returned to where it was at the beginning of 2020, just under 4%.
One indicator not fully back to normal is of course inflation. Prior to 2019 the economy had an annualized inflation rate of 1.8%. By the end of 2020 inflation began to tick upward, peaking in June 2022 at 7.1%. 2023 saw the annualized inflation rate fall back to 3.1%, nearing the Federal Reserve’s target of 2%.
What Was the Root Cause of Inflation?
So what caused the run up in inflation? At the root level Dr. Walden pointed to “supply and demand.” He defined the inflation rate as a percentage change in an average of prices, which is tracked by the Consumer Price Index (CPI). He stated, “When that rate jumps it signifies an imbalance between supply and demand. In fact, there’s more demand than there is supply.”
On the demand side we saw the Federal government, over the course of two administrations, pump 6.5 trillion dollars into the economy as it responded to the pandemic. A lot of that money went to consumers who were staying at home and couldn’t spend it. And on the supply side, we all remember the phrase “supply chain issues.” Once the pandemic began to lift, consumer demand collided with a broken supply chain, creating an imbalance and triggering a spike in inflation.
Will We See Lower Prices in 2024?
While 2023 saw the inflation rate settle back down to 3.1%, what does that really mean? Dr. Walden stated, “I cringe anytime I hear a reporter or news broadcaster say, ‘Inflation is down.’ When they hear that, most people think, ‘Prices are down.’ But of course they’re not. Prices are not down. What the reporter should have said is that the inflation rate is down.” Going forward we can expect to see the inflation rate continue to stabilize, but we shouldn’t expect to see significant price decreases. In fact, Dr. Walden stated, “In a normal economy we do see price increases. When we have falling prices or deflation that indicates a big problem in the economy.”
As we head into 2024 we can anticipate that prices will continue to rise, just not as fast. The supply chain issues have been fixed, and we’ve seen consumer demand stabilize due to the Federal Reserve raising interest rates. The fixes to the supply chain and normal levels of consumer spending mean that the imbalance between supply and demand is resolving, which should lead to the inflation rate continuing to tick downward.
If Inflation is Down, Why Are We So Unhappy?
Despite the inflation rate trending downward, numerous polls indicate that a large percentage of the population is dissatisfied with the economy. Why? Dr. Walden addressed this question by saying, “What people are doing now, and they don’t sit down with a pad and pencil and crunch numbers, but they think about ‘what could I buy with my earnings pre-pandemic and what can I buy now post-pandemic?’ Again, they don’t do this with pad and pencil, but they have a sense that their money does not go as far now as it did pre-pandemic, and actually they’re right.”
Dr. Walden pointed to Real Earnings as the root cause. Real earnings are wages from a job adjusted for inflation. He pointed out that real earnings went down 9% from the Spring of 2020 to the Spring of 2022. Over the last year they improved by just under 2%, giving an overall decline in real earnings of roughly 7%. So essentially, the pandemic gave us all a 7% reduction in pay, and we’re not happy about it. The good news is that as inflation decreases, we’ll see a rise in real earnings.
In the end, 2023 was really a year of good news, even though it may not have felt that way. Dr. Walden stated that the Federal Reserve achieved the ‘soft landing’ they were aiming for. We didn’t see a recession, job creation got back to a normal pace, and consumer spending fell back down to a sane level, and inflation is slowing.
2024 Will Be A Year of Two Economies
Looking ahead to 2024 Dr. Walden sees two economies. The first economy is represented by the first half of the year, and the second is represented by the last half. He believes the Federal Reserve is done raising interest rates. The question is, will the Federal Reserve hold rates here, or begin lowering them? This is where his idea of two economies emerges.
Dr. Walden believes we will not see a reduction in interest rates in the first half of the year, and this will have a negative impact on the economy. He pointed to the Real Interest Rate as the issue. Borrowers and lenders look at the real interest rate, which is the rate stated on a contract minus the inflation rate. As the rate of inflation goes down, the real interest rate goes up. This results in loans and access to capital becoming more expensive, which in turn slows the economy.
The relationship between interest rates and the rate of inflation will be a drag on the economy during the first half of the year, but Dr. Walden doesn’t believe it will lead to a recession. He does think there will be a few bumpy months characterized by slow job growth and lower than expected company earnings, but there won’t be enough drag to send us into a recession.
The Second Half, Better Than the First
In the second half of the year, the second economy that Dr. Walden sees will be brought on by the Federal Reserve lowering interest rates. Dr. Walden stated, “The Federal Reserve will begin cutting rates in the second half of the year, and that will pretty much be welcomed by everyone. It will stimulate the economy and remove any bumpiness we experience in the first half.” He believes that by the end of next year we could see the Federal Funds rate fall to at least 4.25%, if not lower, taking consumer lending rates lower and boosting economic growth.
To his point, we’ve already seen mortgage rates start to tick down simply because lenders believe the Federal Reserve is done raising rates and is likely to start lowering them sometime next year. When the Federal Reserve does officially start cutting, either in March or shortly thereafter, we can anticipate a strong economic reaction that should overcome whatever ‘bumpiness’ we experience in the first half of the year.
How Will a Potential Slowdown Impact Cary?
While the rest of the country might see a slowdown in the first half of 2024, we tend to see ourselves in the Triangle as being isolated from such things. After all, we have a robust and growing economy marked by a steady stream of startups and tech company investments. However, Dr. Walden points out that the data doesn’t support this line of reason. During both the housing crash and the pandemic the Triangle saw negative job growth, just like the rest of the country. If the economy begins to slow during the first half of 2024, we should anticipate some slowing here as well. It may not be as sharp as other areas of the country, but we’re not immune from it.
Conclusion
Reflecting on Dr. Walden’s insights, it’s clear that 2023 brought significant strides in our economic recovery from the pandemic, and the path ahead in 2024 is lined with both challenges and opportunities. His prediction of two economies, shaped by the Federal Reserve’s interest rate policy, offers a crucial lens through which we can view and prepare for the upcoming year. The cautionary note regarding Cary and the Triangle area reminds us that local economies, despite their unique strengths, are not isolated from national trends. Walking away, I felt better equipped for making decisions in the coming year, both in business and maybe even at the voting booth.
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