Will the Fight on Inflation Push the Economy Into a Recession?

Economics 312: Lina Ahmed, Bryam Alvarado, Millenium Amha, Will Anderson, Khoi Dong, Kody Johnson, Alan Nguyen, Henry Petersen, Jayla Ponce, Nathan Stensaas, Molly Thompson

Throughout 2022, the U.S. national economy stayed about even, inflation was elevated and the labor market was tight. The Bureau of Economic Analysis reports that in the first two quarters, the U.S. real GDP declined by an average of 1.1% before increasing by 2.6% in the third quarter.

The Bureau of Labor Statistics reports inflation was an average of 8.3% peaking at 9.1%, the highest since the 1980s. Food and energy prices increased faster than other consumer prices. Food prices increased by 11.4% while energy prices increased by 41.6%. The Federal Reserve (Fed) claims the increasing prices are a result of the Ukraine conflict putting upward pressure on inflation, of demand and supply imbalances due to the Covid-19 pandemic and of a tight labor market. (See figure 2)

Figure 2

The labor market showed a low unemployment rate of 3.5% with robust job openings. In September approximately 800,000 people entered the labor force. Despite the labor force increase, the demand for workers continued to exceed the supply. In August there were 11.2 million job openings, by September these fell to 10.7 million.

The labor market is forecasted to cool with the tech sector implementing hiring freezes and layoffs late in the year. September marked the second consecutive month of falling jobs, the slowest month in the past 18 months. Amazon paused corporate hiring due to an “uncertain” economy. Lyft announced cutting 13% of its employees. Stripe announced cutting 14% of its employees. Twitter fired 3,800 employees, after letting go of 4,400 contract workers.(See figure 1)

Figure 1

The Washington Post reports that retailers reduced their stockpiles after overstocking last year.  Miscalculating consumer demand and declining inventory purchases contributed to the slowdown during the second quarter. High inflation is changing consumer shopping habits. Consumer spending showed modest growth. Goldman Sachs reports spending on durable goods dropped 5.5%, while spending on services grew 4.6%. Expenditure increased on energy, travel and food services.

Energy consumption continued to rise. The $60-a-barrel price cap on Russian oil by the G-7, the EU and Australia took effect on Dec. 5. The EU also banned seaborne imports of Russian oil. In response, Russia warned it would retaliate. President Biden’s 1-million-barrels-a-day oil release from the country’s Strategic Petroleum Reserves (SPR) is to complete in December ending a release of a total of 180 million barrels, reducing the reserves to their lowest since 1984. OPEC+ decided to scale back oil production amid a slowing economy. Electricity demand is growing, however, with wind and solar energy incentives and falling technology costs, production of renewable electricity is expected to increase faster than overall electricity demand. 

Climate change and severe weather continued to impact the country. In 2022, weather disasters cost the U.S. between $82.5-$298.5 billion, compared to $366.7B in 2017 and $248.7B in 2005, by the National Oceanic and Atmospheric Administration. Hurricane Ian, a category 4 storm, struck in September, and the areas hit account for over 15% of Florida’s economic output or about 0.8% of the national output. 

With this economic outlook, fiscal and monetary policies aimed to decrease inflation while promoting economic growth. The Inflation Reduction Act was signed by President Biden on August 16, 2022 with five major components: apply the minimum corporate tax rate; prescription drug price reform; support the IRS to enforce tax policy; extend Affordable Care Act subsidies; and invest in energy security and climate change. The bill represents the administration’s action to cut domestic greenhouse gas emissions by bringing more electric vehicles into service, creating more jobs for U.S. manufacturing.

President Biden also announced a plan to reduce student debt by $10,000 for those earning less than $125,000 each year. Alumni who received federal aid under the Pell Grant program would receive $20,000 in debt forgiveness. The Congressional Budget Office estimates the plan will cost $400 billion. Research shows that waiving student debt will not address the underlying inequalities that created the debt. The Committee for a Responsible Federal Budget recommends debt forgiveness should be accompanied by reforms to create affordable and quality higher education.

In 2022, the federal government spent $6.27 trillion, increasing the federal deficit to $1.37 trillion. While this deficit was lower than the budget deficit reached in 2020, this year’s deficit was higher than 2019’s, continuing the trend of yearly increase in deficit. Federal debt rose to $31.2 trillion by October, up $2 trillion from October of last year. 

Hutchins Center on Fiscal and Monetary Policy uses Fiscal Impact Measure (FIM) to gauge policy impact on the national economy, how the federal, state and local tax and spending policy adds to or subtracts from GDP growth. Fiscal policy helped with economic growth in 2020 but halfway through 2021, FIM turned negative and will likely stay negative. Hutchins Center reports that since the pandemic, there has been heightened uncertainty towards behavioral decisions in legislation, attributed to the waning effects from federal transfers like the unemployment insurance benefit expansions and pandemic-related subsidies.

The Fed responded to high inflation with contractionary monetary policy increasing the Federal Funds Rate from 0.08% in March to 3.78% in November, the steepest increase since the 1980s, and decreasing money supply by 3%. The Fed plans to continue tightening monetary policy while adjusting it based on an updated economic outlook. The response from the Fed to hike rates is challenging as reducing inflation through increasing interest rates by 3% resulted in the 5% reduction of domestic investment and economic contraction. The Fed hopes their tightening monetary policy will maintain a soft landing, avoiding a recession. However, economic outlooks forecast an increasing likelihood of a recession.

Approaching the end of 2022, the near future of the national economy is uncertain. As we combat inflation, global politics and climate change, it’s imperative to remember that there is always an economic cycle. Just as there is a trough, there is also a peak.