Since the beginning of the year, economic data has continued to defy the recession calls of 2022. Therefore, it is unsurprising that economic data surprised analysts’ more dire predictions last year. Of course, given the underestimation of the economy previously, the risk of overestimation is now a real possibility.
The upgrading of estimates also contributed to the discussion of the Federal Reserve’s need to raise the “neutral rate.”
The neutral interest rate is:
“The real rate (net of inflation) that supports the economy at full employment and maximum output while keeping inflation constant.“
(Note: There is no accurate measure of the neutral rate, and it cannot be observed directly. In other words, it is a guess.)
The issue, as always, is that economists are looking at lagging economic data to make assumptions about the future. However, after over 40 years of rising debt levels, economic growth remains slowing. As shown, as debt issuance increased after each economic crisis since the turn of the century, economic growth rates declined. (I have projected the increase in debt based on the average quarterly debt growth since 2018.)
Naturally, if the economy grows at a slower natural rate, inflation and interest rates will ultimately match that growth rate. Furthermore, and most importantly, in the context of this discussion, avoiding a recession becomes increasingly challenging at lower growth rates.
While analysts become more optimistic about economic growth, the divergence of the economic data suggests increased risk to that outlook.