3 Reasons Why Economists and Wall Street Were So Wrong About a Recession

Many economists are "more penalized when being wrong about the downside, so the incentives encourage an economist to be more cynical," a top economist at a major bank told Observer.

Federal Reserve Chair Powell Holds His News Conference Following The Federal Open Market Committee Meeting
Federal Reserve Bank Chair Jerome Powell. Chip Somodevilla/Getty Images

In October 2022, Bloomberg made a bold prediction: There’s a 100 percent chance of a recession in 2023. A similar sentiment was echoed by many, including Federal Reserve economists, major U.S. banks and nongovernmental organizations and agencies. Yet, against these forecasts, the economy stood resilient: 2023 saw a 2.5 percent real GDP growth, with positive growth every quarter of the year, while inflation slowed to 3.4 percent in the last quarter. Here are the three reasons why so many economists were wrong:

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A resilient labor market

Given 40-year high inflation in 2022, most economists predicted the Fed would resort to dramatic rate hikes that would put contractionary pressures on the economy and push it into recession. The Fed did raise interest rates aggressively throughout 2023, but, contrary to expectations, layoffs did not surge (except for Silicon Valley). In fact, Goldman Sachs, one of the few major players that predicted a soft landing rather than a recession, identified a high demand for labor—which was largely resilient to rising rates though it did weather slightly. Because labor supply was tight, firms slowed hiring rather than resorting to layoffs, which heavily insulated the economy from rate hikes.

The construction sector, along with other interest rate-sensitive sectors that are typically prone to layoffs during rate hikes, remained relatively stable. This was, in part, driven by drastic undersupply in the housing sector, so a decline in demand did not rupture the industry.

Strong consumer spending

Despite rising interest rates and prices, consumer spending remained robust, driven by an estimated $5 trillion in government stimulus injected into the U.S. economy in 2020 and 2021 and pent-up savings from Covid-era lockdowns, which accumulated to $2.1 trillion. This gave consumers the cushion to comfortably spend through rising prices; consumer spending makes up 70 percent of the U.S. economy.

Read Also: When Is a Recession Coming? It Depends on Who You Ask

How economists make predictions

The fact that so many economists predicted a recession boiled down to how those predictions were made. Amidst the cascading crises unfolding globally last year, including tensions in Ukraine, challenges in the U.S. commercial real estate market, and China’s zero-Covid policy alongside its debt crisis, many economists believed that the likelihood the U.S. economy would remain unscathed was low. In addition, as the Fed’s rate hikes deteriorated asset prices and overall wealth, it was unclear how resilient consumers would continue to spend despite having access to enormous wells of cash and savings. Thus, along with other macroeconomic indicators taken into consideration, forecasting a recession seemed most probable.

Another reason is the incentives at play for economists when making predictions. “It would take a lot more conviction to break from the consensus than it does to agree with it,” a top economist at a major bank told Observer. They added that many economists are “more penalized when being wrong about the downside, so the incentives encourage an economist to be more cynical.”

Finally, models such as the one employed by Bloomberg in forecasting a 100 percent chance of recession are fundamentally backward-looking. They analyze various variables, extrapolate from historical trends, and make projections based on current data points. However, these models inherently struggle to account for shifts in the economic landscape, structural changes from previous economic environments, or the effects of novel policy measures, such as widespread stimulus checks, on market dynamics.

3 Reasons Why Economists and Wall Street Were So Wrong About a Recession