The U.S. Economic Situation and Outlook for 2023

As the U.S. economy enters 2022’s final quarter, the economic situation is both
troublesome and puzzling. With interest rates rising, and GDP growth falling, it is
disturbing because the year’s weak GDP growth coupled with three negative forces
playing through the economy, offer the strong possibility that 2023 will be an even
weaker negative growth year. Of course, we should recognize that negative growth is
an abstract concept that economy watchers, like me, worry about, but it is holding on to
a workforce, keeping jobs, paying bills, and keeping a business place buzzing that are
the real reasons we worry about the health of the overall economy. After all, for the
construction industry and every other sector, it is what I call The Great American Bread
Machine that sustains and keeps the wheels turning.

But what about those three negative forces at play, and the perplexing part of the
situation? Let’s examine the perplexing part of the situation and then consider the
negative forces.

Here’s the puzzle. Yes, real GDP growth has been in the negative column for much of
this year, but employment growth, national income, and retail sales have been growing
at a healthy pace. With work opportunities flourishing and lots of cash in their bank
accounts, consumers are spending, but not as much on goods as on services.
Manufacturing output has slowed.

In a few words, we seem to have an economy heading south, negative GDP growth,
and north, higher incomes, at the same time. How can that be? And can it continue? I
think we must recognize that government stimulus spending and perhaps the early
effects of pending student debt forgiveness are pushing up income and consumer
spending. Yes, it is COVID related, and yes, it will end. Meanwhile, the production and
construction economies are still heading south, and that will continue so long as interest
rates are rising. As the Fed reminds us, the rising interest rate march may have just
begun.

Well, what about the three negative forces? I first note that COVID’s negative effects
are still very much with us. Even now, after almost two full years that included
disturbances and shutdowns, important markets are still out of synch. Just in
September, lumber prices finally fell to their pre-pandemic level, but other commodity
prices are still levitating. For example, the construction materials PPI was rising 35%,
year-over-year, in February, 2022. Things are a bit better. It was growing at “just” 8.90%
in August 2022. But the industrial building material PPI was cruising upward at more
28% in August.

Even with construction slowing, there are still a lot of supply bottlenecks remaining.
When we look at labor markets, we see that wages are rising across the economy, and
in spite of the slowing economy, employers are still struggling to fill job vacancies. This
said, we should also note that nationwide growth in job opening is over. While the
economy heads south, labor markets are becoming better balanced. While getting
balanced, those finally re-entering the labor force are, on average, less skilled and
experienced than those already employed. This means, labor productivity is falling, and
that contributes to falling GDP growth.

The Russia/Ukrainian war and related energy market disturbances is the second
significant negative force affecting the economic outlook. Each day of war brings
destroyed human life, houses, factories and other structures and long-sustained capital
for producing goods and services. The result is obvious. The world is made poorer. But
destroyed human and physical capital is just one horrible element of the struggle.
Added to this are disruptions in energy markets that bring reduced prosperity or worse
to European and other economies. Better insulated from this than most advanced
economies, the United States is still hit by higher priced energy and energy-intensive
goods. The result is higher priced travel, heating, cooling, and production. From all
indications, this second dark cloud will be with us on into 2023.

Finally, the third negative force is inflation and the Fed’s stalwart effort to bring it down.
At this point, the Fed’s decision to raise interest rates has just begun to take a bite out
of the economy. Yes, housing starts are down, construction permits are down even
more, exports are down and the number of hours worked in manufacturing has fallen.
But even though fixed mortgage rates are now over six percent and 10-year
government bond rates have touched five percent, when compared with eight percent or
more inflation, the result still yields a negative cost of borrowing. Because of this, the
Fed will predictably hit the brakes a few more times in the next six month, and the
economy will respond with even slower growth.

To summarize, I conclude by saying we have a disturbing and perplexing economic
situation, one that is yielding negative real GDP growth that will likely continue into
2023, but an economy that is still responding positively to COVID and other stimulus
spending. The effects of this spending will wear thin in 2023, and we will be left with a
more balanced economy but one that is experiencing recessionary growth.
So, keep your seatbelts fastened. There may be rough weather ahead. And there is
always the possibility that the darker negative forces will ease sooner and The Great
American Bread Machine will start humming again.

Bruce Yandle is Alumni Distinguished Professor of Economics Emeritus, Clemson University, and Distinguished Adjunct Fellow with the Mercatus Center at George Mason University where his quarterly Economic Situation Report is posted.