Why Were Economists Wrong About a 2023 Recession?

In early 2023, most economists predicted the U.S. economy would fall into recession by year end. Instead, the economy continued expanding, with GDP growing by a very solid 2.5%. Why were they wrong, and perhaps more importantly, why is the economy unlikely to outperform again in 2024? Three reasons:

High interest rates did not hurt as much as everyone thought. Between March 2022 and July 2023, the Federal Reserve (Fed) increased its policy rate by 5.25 percentage points, the most in over four decades. Such an increase in the cost of credit would normally bring the economy into a sharp recession. However, this largely did not happen. Many firms and households took advantage of record-low interest rates in 2020 and 2021 and refinanced their debts. High interest rates created some turmoil in March 2023, when they led to a collapse of Silicon Valley Bank and two other banks. The swift and decisive action by the Fed prevented these failures from spilling over to the broader economy and left it surprisingly unmoved by the effect of monetary tightening. However, high interest rates remain in place. Many of the loans refinanced right after the Covid-19 pandemic are due for refinancing in 2024, with more than $900 billion due in the Commercial Real Estate sector alone. Although the Fed is likely to start cutting rates this year, the policy easing is likely to be gradual. The full impact of higher interest rates is yet to unfold.

Consumer spending proved much more resilient than expected. Pandemic restrictions kept millions of people at home and prevented them from living and spending money in their usual ways. In addition, government-issued stimulus checks put additional funds in their pockets. As a result, households accumulated an enormous amount of so-called “excess savings,” estimated at around $2 trillion, or over 8% of GDP, in mid-2021. These savings subsequently fueled the consumption boom in 2021 and 2022. According to the data available at the time, the stock was largely exhausted by the end of 2022. However, consumer spending continued at a fast pace in 2023, baffling the observers. The mystery was largely solved following the revisions to the National Income and Product Accounts in September 2023. According to the revised data, the stock of excess savings proved to be around $1 trillion larger than previously estimated and continued to boost consumption throughout 2023. Those excess funds are estimated to be almost exhausted by now and are unlikely to boost the economy in 2024.

Fiscal policy continued to support the economy: The pandemic saw an explosion in the size of the U.S. federal deficit and debt, as government deployed measures aimed to sustain the economy bound by public-health restrictions. As the pandemic passed, fiscal policy was widely believed in need of tightening in 2023. However, two acts of Congress, the Inflation Reduction Act (IRA), and the Creating Helpful Incentives to Produce Semiconductors (CHIPS) act, enacted in 2022, partially reversed the fiscal tightening process and led to an increase in the federal government deficit from $1.4 to $1.7 trillion in fiscal year 2023, or 5.3% to 6.3% of GDP. Fiscal deficits of that size are not sustainable, and fiscal policy is currently on its way to tightening again, with the Congressional Budget Office projecting the deficit to shrink to $1.5 trillion in 2024, or 5.3% of GDP.