The COVID-19 pandemic notably, and inevitably, changed our behavior relating to economic matters. More than two years on, the global economy—despite some gains—is still struggling to fully recover. And economic experts, including Dr. Anirban Basu, predict it will get worse before it gets better.
“Things in the past couple of years have been pretty good—low unemployment, lots of consumer spending, lots of job growth,” says Basu, an economist and chairman/CEO of consulting firm Sage Policy Group, during the 2023 Laser Focus World Executive Forum in January (see video). “It’s the future that is worrisome.”
Throughout much of the height of the pandemic period, there has been “furious growth” in money supply, which Basu notes can be attributed to Federal Reserve and other central banks. They expanded their balance sheets to attract borrowers and entice them to borrow more—efforts the banks hoped would offset the pandemic’s worst effects on the economy.
“When things become more scarce—in this instance, money—the price of something goes up,” Basu says. “But as the price of money, the interest rates, go up and when you’ve got a group of rapidly growing businesses that form a very rapidly growing industry like photonics, this can of course produce risky business.”
The culprit? Inflation.
The global goal has been to wring excess inflation out of the global economy. One way to meet that goal—raising interest rates to reduce the demand for borrowing. In turn, there will be less money flowing through domestic and/or global economies. Born instead out of the pandemic, however, has been excess inflation.
In January 2020, just ahead of the pandemic’s onset, the International Monetary Fund, in its World Economic Outlook (WEO), forecast that global inflation would peak at about 5% at the end of the following year. Later forecasts exhibited similar hope.
“But they had been too optimistic,” Basu says, noting that even as inflation was blossoming in America in 2021, economists believed the excess inflation was fleeting. “The notion was, ‘Don’t worry about this. We’re coming back from the worst of the pandemic. Inflation will be over very, very quickly. We’ve got this under control.’ We didn’t have this under control. This bout of enduring inflation has surprised a lot of people with its ferocity.”
Globally, average inflation rates hovered around 9.8% in 2022. The U.S. alone saw a 9.1% peak, according to the U.S. Bureau of Labor Statistics—the largest increase in 40 years.
This rate of inflation is decelerating, with the core rate (tallied after food and energy costs) hitting 5.7% by the end of last year.
“But that’s still too fast for the Federal Reserve’s taste,” Basu says, noting that the target is 2% per annum. “It’s akin to having a neighborhood with a 20-mile-per-hour speed limit, but people in general are going 90 miles an hour. The American consumer, in particular, has managed to look inflation right in the eye and spend right through it.”
The Federal Reserve sees this as problematic, so slowing that inflation growth prompts higher interest rates. This impacts household finances, as people ultimately are paying more money for even basic items such as groceries.
Policymakers are trying to engineer a soft landing, explains Basu. “They want to slow the economy down and wring excess inflation out of the economy without driving us into recession,” he says.
But such changes won’t happen overnight. After all, it can take at least 18 months to two years for tighter monetary policy to materially affect inflation—and the Federal Reserve didn’t begin increasing interest rates until March 2022. “The Federal Reserve has done so much already (having taken rates from effectively 0.25% to 4.5% in less than a year),” says Basu. “Let the medicine take its course. Whatever investors are thinking, or pundits are saying, the Federal Reserve is very clear—they’re here to stomp on inflation.”
This same logic has been spreading globally. Monetary policy is tightening, interest rates are rising, and it’s becoming more expensive to borrow in much of the world, including North America, Europe, Latin America, Australia, and South Africa, notes the Council on Foreign Relations, as they target inflation in some manner.
“To this point, the economy is not in recession,” Basu says. In fact, Gross Domestic Product Growth, per the U.S. Bureau of Economic Analysis, shows the U.S. increased by 2.9% in the fourth quarter of 2022. “Indeed, this is the broadest measure of U.S. economic progress.”
Current-quarter growth is forecast at less than 1%, however—a sign that the economy is slowing.
But the labor market is very strong, with a constantly growing pool of talented workers in many industries. Since February 2020 (the month before the pandemic stalled the economy), the U.S. has added 1.239 million jobs, Basu says, “and many employers are seeking to hire even more than that. The human capitalist has made an extraordinarily strong labor market.”
Professional business services positions worldwide—accounting firms, attorneys, etc.—have seen the largest growth, attributed in part to employees being able to work remotely.
Unemployment rates, particularly in advanced economies, have bounced back considerably over the past two years. Canada’s unemployment rate is very low by historic standards and U.S. unemployment sits at just 3.5%—a pre-pandemic level. “The good news is working people are in demand. The labor market is strong, it’s forceful right now,” Basu says. “The bad news, of course, is inflation.”
Hard work lies ahead
“When this bout of enduring inflation began, a lot of it came from supply chain issues,” he says. “And that’s why the Federal Reserve said this was transitory. They believed the supply changes would go away, and inflation will go away with it and we’ll be fine. They were wrong.”
The source of inflation or hyperinflation—wage growth, wage pressures, and higher compensation costs. “To counter all this inflation,” Basu says, “you have to hammer the labor market. Bring unemployment in the United States up from 3.5%. But that causes pain. And now we want to know, can the Federal Reserve or other central banks engineer that soft landing, or are we headed for recession?”
Defined by the National Bureau of Economic Research (NBER), a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
However, the rules are unclear. “When they say it’s a recession, we view it as a recession. They have the rules. But there is no fixed rule about which indicators contribute information to the process or how they are weighted in the determination of recession, per the NBER,” he says. And because government economic statistics are published at various lags, the NBER Committee cannot officially designate a recession until after it starts, and often not until it’s over.
“So, it’s conceivable that we won’t even have a recession,” Basu says, although he notes some key indicators. “One of them is the stock market.”
Last year, the S&P 500 fell around 9% to 20%. The Dow was down 10%, NASDAQ was down 30%, and Bitcoin was down 65%. People believed the economy was weakening, Basu explains, which is not good for corporate earnings or employment rates. An August 2022 PwC Pulse Survey of U.S. executives found that 50% of firms anticipated a reduction of overall headcount in the next 6 to 12 months. Such job corrections, of course, can benefit other sectors. “If Google lets go of 12,000 employees, many of them engineers, that might spur recruiting in the photonics industry,” says Basu.
Another strong indicator is the real estate market, whether that’s buying and selling houses or architecture and construction. “One of the parts of the economy that’s most affected by higher interest rates flows during construction,” Basu says. “The housing market has been positively frothy. Up until March or April of last year, routinely, people who are trying to sell a home would have bidding wars over their homes because of low inventory, price, and so on. But that was then and this is now.”
He notes that the Federal Reserve increasing interest rates beginning in March 2022 has impacted other interest rates—those they don’t directly control but do have influence over, including mortgage rates. The number of mortgage loan applications, including refinancing loans, filed in the U.S. have dropped sharply in the past several years, according to the Mortgage Bankers Association, which Basu says can be attributed to high interest rates.
“I don’t buy the house, therefore I don’t buy furniture, I don’t buy drapes, I don’t do all kinds of things,” he says. “And so, I’ve taken away some vital economic activity. I don’t go to the settlement table, so the mortgage banker doesn’t earn a fee. I don’t allow the title company to earn a fee, and so on.”
This has also prompted a stall in the real estate market overall, and extends to the architecture and construction sectors, as well, because the source of strength for the global economy is now in retrenchment. “That’s one of the aspects of the economy that I think you’ll see weaken further in 2023,” says Basu.
One exception has been the apartment and condominium construction market. This should remain strong, Basu explains. “All things being equal, higher mortgage rates are good for that market because if I can’t buy a home, I end up renting.”
Road ahead
Looking to the future, Basu says getting the inflation rate under control will be key. This would give the Federal Reserve the freedom to stop raising interest rates, and maybe even begin cutting them. But for now, some economic segments, including public construction, are expected to hold up better than others. Public works projects (roads, bridges, water and sewer systems, etc.) should be a focus for the next several years, Basu predicts, as government funding for such infrastructure already exists, at least right now. Food stores and multifamily housing should also fare well.
“At some point, the Federal Reserve will stop raising rates,” Basu says. “That will represent a key inflection point for the economy, and it could start a market rally, whether during that period or in anticipation thereof. I think 2024 will be a much better year for the global national economies.”
