MIKE WALDEN COLUMN: Will 2024 be a year of two economies?

Published 9:56 am Thursday, December 21, 2023

It’s the time of year for economists like me to give absolutely error-proof forecasts of what the economy will be like in 2024.

Mike Walden

Of course, I am teasing about my — or any economist’s — forecast being perfect. That’s impossible, as there can always be unforeseen events that change the economy. How people react to economic conditions can differ from how they responded in the past, thereby making forecasts based on past reactions wrong. This was a big problem for forecasts during the COVID-19 years.

Now that I have sufficiently lowered your expectations about what economists can deliver in forecasts, let me go ahead and tell you what I think will happen in 2024.

I’ll start with some background on the 2023 economy. A year ago, many economists expected a recession in 2023. It didn’t happen. Remember, a recession occurs when the major measures of economic activity, like spending, production and employment, shrink. These indicators all expanded in 2023, although at the end of the year the pace of expansion was slowing. The biggest economic problems in 2023 continued to be inflation rates higher than most people find acceptable, as well as high interest rates.

Now on to 2024. I think there will be two different economies during the year. The first half of 2024 will be challenging, perhaps including a mild recession. The second half will be the opposite, with a rebound in economic growth, moderating inflation, and — finally — lower interest rates. This is why I call 2024 the year of two economies.

Let me dig deeper and more fully explain my forecast. As it became evident in 2022 that inflation was a problem, the Federal Reserve (Fed) began to aggressively increase its key interest rate, and other interest rates followed. The Fed did this to slow the pace of economic growth and take the pressure off prices.

Although average prices continue to rise, the size of increases has moderated, from an annual high of over 9% in mid-2022 to an annual rate of nearly 3% in late 2023.

However, the Fed’s policies operate with a considerable lag. I see the Fed’s high interest rate policy having its biggest impact in early 2024. Here’s why.

First, the Fed hasn’t yet reached its inflation goal of a 2% annual rate, about the level that existed prior to the pandemic. So, while the Fed likely won’t further raise interest rates, it is not yet ready to lower interest rates until the 2% rate is in sight. I expect the Fed to hold tight on interest rates until around mid-2024.

But, if the Fed keeps interest rates where they are, and if the inflation rate continues to trend lower in early 2024, this ultimately makes the cost of borrowing higher. How so? Because the real cost of borrowing is the difference between the interest rate on the loan and the inflation rate.

If the average borrower expects their income to rise at the rate of inflation, then the important cost to the borrower is the difference between the interest rate and the inflation rate. If that difference rises, then the cost of loans increases.

If in the first half of 2024 the Fed keeps interest rates stable, but if at the same time the inflation rate is moving lower, then the real cost of loans becomes higher. This means both businesses and households will borrow and spend less, resulting in less economic activity.

There can be two alternative results of this situation. The economy could still continue to grow, but just at a slower pace. Spending, production and jobs will all increase, yet at a slower rate. This is similar to what has happened in the final months of 2023. I’ll call this outcome a slowdown.

Alternatively, if the slowdown is so strong that it turns into a downturn, then we would see spending, production and jobs drop. If these drops were significant enough, widespread and lasted long enough, then the situation could ultimately be labeled a recession.

My own view is we won’t have an official recession in early 2024. Instead, we will have a slowdown, but with some months worse than others, meaning some months could have reductions in spending, production and jobs. But the jobless rate will not reach double-digits, like it did in the last two recessions. In the worst-case scenario, I see the jobless rate peaking at between 5% and 6%.

The second half of 2024 will be much better, mainly because it is then that I think the Fed will begin cutting interest rates. With the Fed’s reduction in interest rates proceeding faster than the moderation in the inflation rate, borrowing will become cheaper.
With less expensive borrowing, businesses and households will borrow and spend more, resulting in a stronger, growing economy. By the end of 2024, the annual inflation rate will be near the Fed’s 2% target, and the unemployment rate will be within the 3% to 3.5% range.

In summary, I see a challenging but not disastrous first half of 2024, followed by an improving and optimistic second half of the year. How challenging the first half is will determine if an official recession has occurred, or if the result has only been a slowdown.
Of course, during the challenging first half, not all sectors will be impacted the same. Those sectors which will be more challenged likely include commercial real estate, construction and manufacturing.

I had an uncle who always said, give me the bad news first and the good news second. You can read my 2024 forecast by adhering to this advice. You decide if the overall picture for 2024 is a net plus or a net minus.

Mike Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.