Households continued to draw on a large stockpile of savings to maintain spending despite inflation weighing on real income. In addition, many households and businesses had locked in low interest rates in 2020 and 2021, leaving them insulated from higher rates. A backlog of uncompleted housing units as a result of COVID-era supply bottlenecks also supported employment in construction even as the housing market adjusted to higher rates. And more recently, there have been early signs that the Biden administration’s major policy initiatives are beginning to support investment in infrastructure projects and manufacturing facilities, adding an additional tailwind to the economy, albeit a modest one.


Figure 1: Policy Stance Turned Restrictive In 2023

Real Policy Rate Less Natural Rate Estimate

All this raises the question of whether these sources of resilience can continue to underpin the economy, extending the runway for inflation to moderate and ultimately setting the stage for rate cuts and an extended expansion. We remain skeptical. First, excess household savings look set to run out by the end of this year. In addition, many households have increasingly turned to borrowing to support spending, an unsustainable trend in an environment where banks are tightening lending standards and looking to preserve net interest margins as funding costs increase.  As for the corporate sector, profit margins remain elevated by historical standards but are likely to continue to compress given a weak global growth backdrop and ongoing cost pressures, including on the labor front. Margin compression could in turn weigh on capital investment and labor demand, which has already shown signs of moderating in recent quarters.

Figure 2: Average Weekly Hours of Production & Nonsupervisory Workers

In addition, the resilience story should not be overplayed. Monetary policy only turned restrictive this year, hence the economy’s solid performance should come as no surprise. And policy will only turn more restrictive as the Federal Open Market Committee tightens further. The full effects of cumulative tightening still lie ahead.

The soft landing narrative also anticipates a near-normalization of inflation without a meaningful hit to growth and employment. This may be challenging to achieve. Inflation in many categories, such as durable goods and housing, should continue to moderate in the months ahead. But if the labor market remains strong, with firm wage growth, discretionary services inflation may remain sticky. That would set the stage for a sustained period of restrictive policy.  And the historical record of such periods suggests that risks of an outright contraction remain elevated, even if the economy’s recent performance and various tailwinds signal that a downturn is not imminent.


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