Moody’s Mark Zandi is upbeat on the economy though challenges loom from COVID and Ukraine
Despite all the economy is dealing with, the odds are still better than even that the economy will return to full employment by late this year.
Handicapping the economic outlook has suddenly become difficult. Will our strong economic recovery evolve into a self-sustaining expansion with low unemployment and more comfortable inflation? Or is the economy headed into recession? Or, even worse, are we headed for stagflation with both high unemployment and inflation?
The cloud in my crystal ball is Russia’s invasion of Ukraine. The direct blow to our economy from Russia’s incomprehensible actions is small. Our businesses and banks have little to do with Russia given previous sanctions we imposed on the country. Unfortunately, the hit is magnified by bad timing, since our economy is still grappling with fallout from the ongoing pandemic.
To be clear, despite all the economy is dealing with, odds are still better than even that the economy will return to full employment by late this year, marked by an unemployment rate closing in on 3%. And while it will take another year or so, inflation will fall back to a much more comfortable level closer to 2%.
This sanguine outlook rests on several key assumptions. First, the pandemic must continue to wind down — with each new wave of the virus less disruptive to the economy than the one before it. This has been our experience of the last two years. Omicron made lots of people sick, but it wasn’t nearly as problematic as the delta wave that hit last fall, which was less troublesome than the alpha wave of last winter.
As the pandemic fades, people are getting back on the job and open positions are getting filled. Wage and price pressures should soon moderate. Scrambled supply chains will also untangle, easing shortages and prices. Some of the worst bottlenecks have already been ironed out, and global trade has ramped up in recent months.
The economic outlook also depends on Russia finding a way to stand down from its hostilities. Perhaps not next week or next month, but in coming months. The principal link between Russia’s invasion and our economy is oil prices, which have jumped by about one-third. This has boosted prices at the pump by nearly $1 to well over $4 a gallon. The typical American household will spend about $100 more a month this year to fill the gas tank. This is painful, but if this is near the worst of it, the economic recovery will go on.
The Federal Reserve also needs to nail monetary policy. That is, it has to raise interest rates fast enough to quell high inflation, but not so fast that it undermines growth and the recovery. This will be tricky. The Fed was understandably slow to start raising rates given uncertainty around the pandemic and the Russian invasion. But in hindsight it is clear that the central bank waited too long. Policymakers have much work to do to get rates up where they need to be.
If any of these assumptions don’t hold, more-or-less, our economic recovery will quickly be in jeopardy. And there are reasons to worry they won’t. Consider the reemergence of the virus in China and other parts of Asia, where most supply chains begin and pandemic responses are more restrictive. China appears to be relaxing its no-COVID policy to keep factories running and ports open, but if this fails, there will be more shortages and higher prices here.
Of course, Russia’s invasion of Ukraine could take a number of darker turns leading to much more serious economic consequences. It is easy to foresee the conflict intensifying, resulting in even stiffer sanctions on Russia, including a European ban on Russian oil imports.
This loss of Russian oil from global markets would be difficult to replace anytime soon, and oil prices would spike even higher. The higher oil prices and resulting inflation surge would almost surely undermine already fragile consumer, business, and investor sentiment. Inflation expectations, already high, could be completely dislodged.
The Fed, faced with a Hobson’s choice of responding to the struggling economy or to higher inflation, would likely decide to rein in the inflation.
Policymakers will appropriately figure it is better to risk a near-term recession than stagflation, which, based on the debilitating experience with stagflation two generations ago, can ultimately only be dealt with by an even more severe downturn.
My crystal ball could be overly gloomy.
Little noticed is the revival in productivity, which means we don’t need to work as hard to produce more. The shackles put on productivity since the financial crisis have been broken, and the widespread adoption of remote work during the pandemic augurs well for even stronger productivity gains. There is no better antidote for recession and stagflation than stronger productivity. Of course, even better would be a bit of good luck. We are certainly due.
Mark Zandi is chief economist of Moody’s Analytics.