Dude, where’s my recession?

But the meaning of an inverted yield curve is widely misunderstood. It doesn’t cause a recession. It is instead an implicit prediction about future Fed policy – namely, that the Fed will cut rates sharply in the future, presumably to fight a deepening recession. So the inverted yield curve wasn’t really independent evidence, just a market reflection of the same “recession is coming” consensus you were hearing on cable TV.

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So where did that consensus come from? Leaving aside all the “Biden’s socialism will tank the economy” takes, I think it’s fair to say that most economists bought into the view that we were seeing a replay of the early 1980s. What happened then was that, faced with high inflation, the Fed sharply raised interest rates, causing a recession; this recession brought inflation down, and the Fed then reversed course, cutting rates again.

Indeed, the Fed has, once again, raised rates sharply to fight inflation. But events since then have failed to follow the script in two distinct ways.

First, those rate rises have so far failed to produce a recession. Instead, the economy has been remarkably resilient. Mortgage interest rates – arguably the most important place where the rubber of monetary policy meets the road – have soared over the past year and a half.

Yet unemployment hasn’t meaningfully gone up at all, which isn’t what most economists, myself included, would have predicted. Why not?

Part of the answer may be that housing demand surged in 2021-22, largely as a result of the rise in remote work, and that this increase in demand has muted the usual negative impact of higher rates. This is especially true for multifamily housing, where high rents have given developers an incentive to keep building despite higher borrowing costs.

Another part of the answer may be that the Biden administration’s industrial policies – in effect, subsidies for semiconductors and green energy – have led to a boom in nonresidential investment, especially manufacturing.

There may be other factors as well, like all the “revenge travel” Americans have been doing as fear of COVID-19 fades. Whatever the reasons, the economy has shrugged off higher interest rates to an extent few expected.

Now, you might think that this means that the Fed will have to push interest rates even higher. After all, don’t we need a recession to curb inflation? But here’s the other place where things have gone off script: despite steady job growth and continuing low unemployment, inflation has in fact subsided. This is true even if you look at measures that try to exclude transitory factors. My preferred measure these days is “supercore”, which excludes food, energy, used cars and shelter (because official measures of housing costs still reflect a rent surge that ended a year ago.)

This is the measure I’ll be looking at when new inflation numbers come in Wednesday. (The Fed has a different measure of supercore – non-housing services – but when you look at the details of that indicator, it’s a dog’s breakfast of poorly measured components that I find hard to take seriously.)

In any case, something really strange has happened. I can’t think of another example in which there was such a universal consensus that recession was imminent, yet the predicted recession failed to arrive.

This article originally appeared in The New York Times.

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