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February job growth was much higher than expected (311k jobs versus a forecast of around 223k). If that phrase sounds familiar to you, that’s because it also happened the previous month. And the month before that. And the month before that.
In fact, the hiring rate has now surpassed Wall Street consensus forecasts for 11 straight months. Which is pretty unusual. You see, forecasting is always difficult, and the numbers rarely come out exactly as predicted, but it’s surprising that month after month, the experts keep getting wrong in exactly the same direction. That is, they are always too pessimistic.
There was good reason to expect key economic indicators such as the hiring rate to slow down month-on-month. After all, the US Federal Reserve raised interest rates eight times in the past year, with the express aim of cooling the hot economy and bringing inflation back to more normal levels. Economists and politicians have been warning for months that these rate hikes could not only delay economic recovery but also trigger a recession.
But (fortunately) the recession hasn’t hit yet. Like Godot, it’s always just around the corner. But why does almost everyone keep underestimating the strength of the economy? In other words, why has the economy stayed so hot despite all these rate hikes?
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The answer isn’t that forecasters are a bunch of negative Nellies or right-wing partisans downplaying the strength of the economy (to make President Biden look bad, or whatever the conspiracy theory may be). Wall Street forecasters are definitely trying to get the numbers right so they can make money.
A few possible explanations:
1) Maybe something strange happened with the numbers and our measurements are wrong.
I don’t mean that someone cooks the books. Rather, response rates to the government surveys used to calculate key economic indicators have fallen sharply. That could skew the numbers in ways that are difficult to explain in advance, and lead to major revisions to the data later.
Or maybe we’re not paying attention to the right numbers. For example, there have been recent problems in the banking sector that may not yet be reflected in federal jobs or consumer spending data. Other, “softer” economic indicators like consumer sentiment are also looking quite negative.
2) Monetary policy may be operating with a longer lag than expected and we will see the impact of these rate hikes a bit later. The housing market, one of the most interest rate sensitive sectors of the economy, is already in decline; maybe other industries will follow. (Although construction companies, oddly enough, continue to hire workers, another mystery I’ll get to in a moment.)
3) We don’t know what the economy would have looked like without all these Fed rate hikes. Maybe it would have simmered even more. So maybe the Fed has already slowed things down quite a bit – it’s just not particularly obvious because we’re comparing current conditions to the wrong alternative scenario (‘counterfactual’, in geekspeak).
4) Fiscal policy – ie spending and tax decisions – may continue to stimulate the economy more than economists expected or understood. That could counter some of the things the Fed has done.
The conventional wisdom is that fiscal policy is currently rather a drag on the economy. Which makes sense: Federal stimulus checks, the expanded child tax credit, and other emergency Covid-19 programs that spurred consumer spending are mostly in the rearview mirror. But remember, federal agencies aren’t the only ones making important tax and spending decisions.
Almost every state has cut taxes in the past two years. About half of the states are now considering further tax cuts. These state tax cuts were made possible in part by the strong economy and in part by generous, deficit-funded federal funds (like Biden’s American Rescue Plan). The states are redeemed, and instead of saving their surplus for a rainy day, many of them are handing out cash to residents.
Because available data on state-level budget decisions is not particularly good, economists may not pay enough attention to how they affect the broader economy.
Also: At the federal level, too, many expenditures from industrial policy programs (infrastructure, climate, semiconductor subsidies) are collapsing. It’s early days, so these programs probably haven’t been particularly stimulating yet. But some economists have suggested that one reason the construction sector is continuing to hire despite the slowing housing market may be that employers expect to be competing with government contractors for labor fairly soon.
5) The effects of Covid are weird and wild and difficult to understand.
We haven’t seen anything like the recent pandemic in a long, long time, and never in what looks like a tightly interconnected global economy. Even the experts don’t have great precedent or models to base their predictions on.
Maybe everyone is wrong on the side of being a little more conservative – and stingy with their optimism.
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