The economy is resilient despite hot inflation

The U.S. economy has proved far more resilient than anyone could have expected despite the Federal Reserve’s efforts to cool it to rein in inflation. The Goldilocks outcome of strong growth and lower inflation was achieved by a timely expansion in the supply side of the economy—mainly better-than-expected gains in the workforce and productivity. This explains our updated economic forecasts anticipating stronger growth, a sturdy labor market, stubborn inflation, and a Fed that will move cautiously toward its first rate cut—including the possibility of not being able to cut interest rates at all this year.

Supply-side forces in the driver’s seat

Given policy interest rates aimed at subduing inflation by restricting economic activity, we would not have expected GDP growth as robust as 3% in 2023. Stronger-than-expected labor supply and productivity gains more than offset the Fed’s aggressive monetary policy tightening. These favorable supply-side forces are likely to subside only gradually, boosting our outlook for 2024. We foresee economic growth around 2% for 2024 and a year-end unemployment rate around 4%.

Meanwhile, we expect demand to persist. As the economy remains resilient and with strong underlying demand, we continue to see the “last mile” of the inflation fight as the most difficult. We believe that the core Personal Consumption Expenditures price index, the Fed’s preferred measure of inflation, won’t follow a smooth path toward the Fed’s 2% goal, with the risk of staying above 2.5% for the year, higher than previously anticipated. (Core inflation excludes volatile food and energy prices.)