Politics & Government
Wesleyan economist praises Federal Reserve for reducing inflation
Zelity believes housing market will improve as interest rates are lowered
By Scott Benjamin
Wesleyan University Assistant Professor of Economics Balazs Zelity states that the Federal Reserve Board’s recent decisions are largely responsible for what appears to be a soft economic landing following the highest surge in inflation in more than 40 years.
Since Spring 2022, the Fed has increased interest rates to their highest level in 22 years, has held them steady over the recent months and might reduce them in 2024, according to Wall Street Journal economics correspondent Nick Timiraos.
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The December 2023 inflation rate was 3.4 percent – well below the 9.1 percent recent peak in June 2022. The unemployment rate currently stands at 3.7 percent – about where it was in early 2020 shortly before the pandemic. At that juncture the unemployment rate was the lowest since 1969.
“In my view, the Federal Reserve’s performance over the past 18 months has been a textbook example of how monetary policy should work,” Zelity wrote in an e-mail interview with Patch.com “Continued interest rate increases have been driving a steady decline in inflation towards the Fed’s goal of 2 percent.”
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He added, “It was also wise to halt interest rate increases for the time being, because monetary policy works with a lag. That is, it takes time for inflation to respond to interest rates. Indeed we see that inflation continues to decline even as the Fed keeps rates steady at relatively high levels. The question now is whether we can reach 2 percent inflation with the current level of interest rates. The Fed and financial markets both believe this is the case.”
“The U.S. economy appears to be on the path for a soft landing,” Zelity stated. “Of course, there are always uncertainties, but a soft landing seems to be most likely scenario for the time being.”
A recent Wall Street Journal sub-headline stated: “What does it take to buy a home in the U.S.? A lot more than it did before the Federal Reserve Board raised interest rates.”
Zelity predicts improvement in 2024.
“The housing market’s biggest issue right now is perhaps the lack of supply,” he wrote. “The reason is that high interest rates make people who had locked in low-rate mortgages reluctant to sell their current homes and take out a high-rate mortgage for a new home. This issue should be ameliorated once the Fed starts cutting rates. So yes, we should presumably see the number of transactions increase on the housing market in 2024.”
He added, “Lower rates, however, would also increase demand. So, on balance, it is unclear what will happen to prices. In addition, while I do expect the Fed to start cutting rates in 2024, it is possible that those cuts will be gradual, slow, and come later in the year. In that case, it might not be until 2025 that rates get sufficiently low to improve market conditions meaningfully.”
New York Times economics columnist Peter Coy recently expressed concerns regarding a reduction in temporary-agency employment; weak small business confidence and financial distress over credit cards and auto loans that resembles the Great Recession of 2007-2009.
In contrast, Zelity stated, “I would be on the optimistic side for 2024. While there has been an uptick in certain loan delinquencies, these are nowhere near Great Recession levels. Surely, there is always a risk that some relatively hidden vulnerability in the economy balloons into a larger crisis, but I don’t see a compelling case for this being a highly likely scenario for 2024. In my view, at least in the baseline scenario and absent any major shocks, 2024 will be characterized by the continued decline of inflation towards 2 percent, and slow but steady interest rate cuts by the Fed to stabilize the economy at 2 percent inflation.”
Yet, even though unemployment is near where it was four years ago – immediately before the pandemic, when it was at its lowest rate since 1969 – polls indicate that voters have a dim view of President Joe Biden’s handling of the economy.
Gallup reports that his 39 percent approval rating is the lowest of any of the last eight presidents entering their fourth year in office.
Zelity wrote “Presidential approval ratings are often driven by factors that are mostly outside of the president’s control. I suspect one reason why President Biden’s approval rating remains relatively low despite a decline in inflation is that prices remain high. Declining inflation means prices have stopped rising, but it does not mean that prices have reverted back to pre-pandemic levels. Nevertheless, wages have kept up with higher prices and unemployment remains low, so the dissatisfaction is quite puzzling, and probably has to do with non-economic reasons such as cognitive biases or the country’s cultural divide.”
On another subject, Wall Street Journal economics columnist Greg Ip recently stated that, “A burst of advances in artificial intelligence [AI], medicine and elsewhere promise a better life down the road.”
Stated Zelity, “Technological improvements such as AI both complement and substitute workers. That is to say, AI will make some workers more productive by allowing them to produce more value with the same amount of labor. At the same time, AI will also completely replace other types of occupations. So, there is a positive and a negative effect on employment.”
He continued, “Overall, historical episodes of transformative technological change have not led to a sustained drop in jobs, so the positive effects will likely outweigh the negative ones when it comes to employment for AI as well. Over the coming years, I don’t expect a big economic impact from AI.”
Resources:
E-mail interview with Balazs Zelity, Monday, January 8, 2024.
https://www.washingtonpost.com/business/2024/01/11/cpi-inflation-december/
https://www.nytimes.com/2023/1...
https://news.gallup.com/poll/5...
https://www.wsj.com/tech/ai/the-future-is-bright-if-you-know-where-to-look-98874b3d
