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What we can expect from the economy in 2023

ROB SCHMITZ, HOST:

Last year's economy was, well, weird. Inflation hit a 40-year high. Interest rates surged. Stocks plunged. Crypto crashed. Yet the job market remained strong. Let's ask David Wessel what to expect in the new year. He's a senior fellow in economic studies and director of the Hutchins Center at the Brookings Institution.

David, good morning.

DAVID WESSEL: Good morning.

SCHMITZ: One of the biggest economic stories of 2022, David, was the Federal Reserve's war on inflation. Is this a war the Fed can win this year?

WESSEL: So I think the honest answer is, maybe. The Fed has raised interest rates very fast, took its key rate from 0 to 4.25% this year. And it says it's going to keep raising interest rates, albeit at a slower pace, until it's convinced that inflation is headed back down towards its 2% goal. Now, some of the forces that had been pushing prices up are abating. The cost of shipping containers across the Pacific is down. Used car prices have fallen for five months in a row. Home prices are starting to come down. And that's going to pull down the headline inflation rate, but probably not all the way to the Fed's 2% goal.

So Jay Powell, the Fed chair, says he's going to keep raising interest rates. He's focused on the pace of wage increases, which he says are simply rising too fast to be consistent with the Fed hitting its inflation target. And he's basically saying, we're going to keep squeezing the economy, holding interest rates at a higher level until the job market weakens and unemployment rises enough that employers don't have to give such big raises to retain workers and the inflation dragon is slain.

SCHMITZ: You mentioned higher unemployment being a consequence of this. What does that say about the risk of recession in the new year?

WESSEL: Well, it means there's a pretty big risk. Look, the Fed is saying, we want to slow the economy. They have said in their public forecast that they expect the unemployment rate, now at a historically low 3.7%, declined by nearly one full percentage point in 2023. That works out to 14 million more workers looking for jobs. Now, whether that means a recession, a shrinking economy, it's hard to say. It's going to feel like one for those workers and their families. There are forecasters who think the Fed can pull this off, can cool the labor market, bring down inflation without triggering a recession. But most of them expect one in 2023.

SCHMITZ: David, a lot has been said about the COVID-related changes in the workplace. I'm talking about, you know, working from home, quiet quitting, early retirement, these sorts of things. Will these trends continue in 2023?

WESSEL: It's a really good question and hard to answer. how much of what happened during COVID is temporary, and we're going to go back to the way things were before, and how much has permanently changed? With so many work - employers complaining about labor shortages, workers have been able to insist on all sorts of flexibility about working from home. But I think if there's more workers looking for jobs, more unemployment, the balance of power may shift towards employers, and it may be that they're less willing to be flexible.

It certainly looks like a lot of people - a lot of office workers - will be working from home at least a couple of days a week. And that really has really negative implications for mass transit systems, for commercial real estate downtown, for the people who sell sandwiches to workers. Meanwhile, there are an awful lot of people still on the sidelines of the labor market, not even looking for work, a lot more than before the pandemic.

So among older workers, the decline in worker - in labor force participation is among the over-70 crowd, not really early retirement. But the fraction of men between 25 and 54, mostly too old to be in school and too young to retire, has been declining for years, took a big plunge during the pandemic. It's been creeping up, but it's still far short of the pre-pandemic level.

SCHMITZ: That's David Wessel. He's the director of the Hutchins Center at the Brookings Institution.

David, thank you.

WESSEL: You're welcome. Transcript provided by NPR, Copyright NPR.