What Could Go Wrong for the Federal Reserve in 2023

In some ways, the 2023 economic outlook for the US is locked in. The Federal Reserve’s goal is to push the rate of inflation back down to 2% over the next few years. It will do this by keeping monetary policy tight enough for long enough to restrain economic activity. This will eventually loosen up the labor market sufficiently to push wage inflation down to the 3% to 4% range consistent with their inflation objective.

Thus, many of the questions posed by market participants are about the margins. How high will the Fed have to raise interest rates? How long will they have to stay there? Will an economic slowdown suffice or will the US fall into recession?

What could go wrong? As I see it, there are three significant risks.

First, economic growth could prove more persistent than expected. Not only did the economy expand much faster during the second half of 2022 than the first, but also the economy will receive additional support next year as federal government outlays surge. The $1.7 trillion government funding bill for 2023 increases defense spending by 10% and domestic discretionary spending by 6%. At the same time, the monthly social security and disability benefit checks to 70 million recipients will rise by 8.7% starting this month. In fact, the increase in recipients’ disposable income will be even larger because Medicare insurance premiums, which are deducted from these checks, will decline this year because the hikes implemented in 2022 turned out to be considerably higher than needed.