The surge in interest rates over the last two years has frequently sparked cautions regarding the business cycle prospects from an economist, echoing prior warnings.
However, when remarks come from a Nobel laureate, the projection carries significant weight, particularly given the recent favorable US economic developments.
According to Joseph Stiglitz speaking at a conference organized by the Japan Society in New York on Wednesday (Feb. 7), the primary near-term peril is that “the central bank escalated interest rates excessively and swiftly.”
He emphasized that the Federal Reserve wrongly diagnosed the inflation spike in 2021-2022, leading to steep interest rate hikes to rein in pricing pressures.
Despite indications that the policy tightening is effectively contributing to the recent disinflation while posing minimal risks to growth, the economics professor at Columbia University remains concerned about potential future difficulties.
Stiglitz asserted that the Fed perceived inflation as a demand-side issue, while he contended that it primarily stemmed from the supply-side.
For instance, he indicated that a significant driver of the current inflation upswing has been the escalation in housing prices, responsible for around one-third of the price surge.
He argued that a critical part of the remedy was an increase in housing supply to alleviate price pressures.
However, by significantly raising interest rates and consequently mortgage rates, a hawkish shift in monetary policy presented obstacles to boosting residential housing construction.
Indeed, housing starts have notably declined since the adoption of hawkish monetary policy in March 2022, as demonstrated in the chart below.
New Privately Owned Housing Units
Stiglitz also predicted that although the US economy “will perform quite well” relative to the global economy overall, the substantial hike in interest rates will continue to pose “a threat to growth in 2024.”
He highlighted the “prolonged and variable impact” of monetary policy as a persistent headwind, underscoring that policy adjustments can take time to fully affect the economy, positively or negatively.
Stiglitz’s expertise in economics provides compelling cause to heed his warning. But for the time being, the US economic outlook continues to defy gloomy predictions from various sources over the past year.
As an illustration, the first-quarter estimate of US GDP via the Atlanta Fed’s GDPNow model (as of Feb. 7) reflects a robust rise in expected output, aligning with the stronger-than-projected Q4 increase reported by the government.
Moreover, based on the Composite Recession Probability Indicator, combining estimates from several models, The US Business Cycle Risk Report, a publication affiliated with CapitalSpectator.com, estimated a mere 1% probability of a recession, or imminent recession initiation (as of Feb. 2).
CRPI Probit Model Estimates
Formulating highly confident predictions for the distant future in business-cycle analysis is extremely challenging. Therefore, prudence in this regard is advised.
Nevertheless, Stiglitz’s caution cannot be easily disregarded. However, based on the current data, recession risk appears minimal – a trend that even a Nobel laureate economist would struggle to dispute, at least for now.