Economists spent 2021 expecting inflation to prove “transitory.” They spent much of 2022 underestimating its staying power. And they spent early 2023 predicting that the Federal Reserve’s rate increases, meant to cure the inflation, would plunge the economy into a recession.
None of those forecasts have panned out.
Rapid inflation has now been a fact of life for 30 consecutive months. The Fed has lifted rates above 5.25 percent to hit the brakes on price increases, but the economy has remained surprisingly strong in the face of those moves. Americans are working in greater numbers than predicted, and recent retail sales data showed that consumers are still spending at a faster clip than just about anyone expected. For now, there is no economic downturn in sight.
The question is why experts so severely misjudged the pandemic and postpandemic economy — and what it means for policy and the outlook going forward.
Economists generally expect growth to slow late this year and into early next, nudging unemployment higher and gradually weighing inflation down. But several said the economy had been so hard to predict since the pandemic that they had low confidence about future projections.
“The forecasts have been embarrassingly wrong, in the entire forecasting community,” said Torsten Slok at the asset manager Apollo Global Management. “We are still trying to figure out how this new economy works.”
Economists were too optimistic on inflation.
Two big issues have made it difficult to forecast since 2020. The first was the coronavirus pandemic. The world had not experienced such a sweeping disease since the Spanish flu in 1918, and it was hard to anticipate how it would roil commerce and consumer behavior.
The second complication came from fiscal policy. The Trump and Biden administrations poured $4.6 trillion of recovery money and stimulus into the economy in response to the pandemic. President Biden then pushed Congress to approve several laws that provided funding to encourage infrastructure investment and clean energy development.
Between coronavirus lockdowns and the government’s enormous response, standard economic relationships stopped serving as good guides to the future.
Take inflation. Economic models suggested that it would not take off in a lasting way as long as unemployment was high. It made sense: If a bunch of consumers were out of work or earning tepid pay gains, they would pull back if companies charged more.
But those models did not count on the savings that Americans had amassed from pandemic aid and months at home. Price increases began to take off in March 2021 as ravenous demand for products like used cars and at-home exercise equipment collided with global supply shortages. Unemployment was above 6 percent, but that did not stop shoppers.
Russia’s invasion of Ukraine in February 2022 exacerbated the situation, pushing up oil prices. And before long, the labor market had healed and wages were growing rapidly.
They were too pessimistic on growth.
As inflation showed staying power, officials at the Fed started to raise interest rates to cool demand — and economists began to predict that the moves would plunge the economy into recession.
Central bankers were lifting rates at a speed not seen since the 1980s, making it sharply more expensive to take out a mortgage or car loan. The Fed had never changed rates so abruptly without spurring a downturn, many forecasters pointed out.
“I think it’s been very seductive to make forecasts that are based on these types of observations,” said Jan Hatzius, Goldman Sachs’s chief economist, who has been predicting a gentler cool-down. “I think that understates how much this cycle has been different.”
Not only has the recession failed to materialize so far, but growth has been surprisingly fast. Consumers have continued shelling out money for everything from Taylor Swift tickets to dog day care. Economists have regularly predicted that America’s shoppers are near a breaking point, only to be proved wrong.
Part of the issue is a lack of good real-time data on consumer savings, said Karen Dynan, an economist at Harvard.
“It’s been months now that we’ve been telling ourselves that people at the bottom of the income distribution have spent down their savings piles,” she said. “But we don’t really know.”
At the same time, fiscal stimulus has had more staying power than expected: State and local governments continue to divvy out money they were allocated months or years ago.
And consumers are getting more and better jobs, so incomes are fueling demand.
Economists are now asking whether inflation can slow sufficiently without a pullback in growth. A landing so painless would be historically abnormal, but inflation has already cooled to 3.7 percent in September, down from a peak of about 9 percent.
Normal may still be far away.
Still, that is too quick for comfort: Inflation was about 2 percent before the pandemic. Given inflation’s stubbornness and the economy’s staying power, interest rates may need to stay elevated to bring it fully under control. On Wall Street, that even has a tagline: “Higher for longer.”
Some economists even think that the low-rate, low-inflation world that prevailed from about 2009 to 2020 may never return. Donald Kohn, a former vice chair of the Fed, said big government deficits and the transition to green energy could keep growth and rates higher by propping up demand for borrowed cash.
“My guess is that things aren’t going to go back,” Mr. Kohn said. “But my goodness, this is a distribution of outcomes.”
Neil Dutta, an economist at Renaissance Macro, pointed out that America had a baby boom in the 1980s and early 1990s. Those people are now getting married, buying houses and having children. Their consumption could prop up growth and borrowing costs.
“To me, it’s like the old normal — what was abnormal was that period,” Mr. Dutta said.
Fed officials, for their part, are still predicting a return to an economy that looks like 2019. They expect rates to return to 2.5 percent over the longer term. They think that inflation will fade and growth will cool next year.
The question is, what happens if they are wrong? The economy could slow more sharply than expected as the accumulated rate moves finally bite. Or inflation could get stuck, forcing the Fed to contemplate heftier interest rates than anyone has gambled on. Not a single person in a Bloomberg survey of nearly 60 economists expects interest rates to be higher at the end of 2024 than at the end of this year.
Mr. Slok said it was a moment for modesty.
“I think we have not figured it out,” he said.