Why Does The U.S. Economy Keep Beating Expectations?

The economy has been defying gravity, and experts aren’t quite sure why. 

Whether it’s the number of jobs added, the amount of money people are spending at stores, or the economic output of the country, report after report has delivered pleasant surprises. It’s also perplexed economists who keep expecting it to slow down at some point.

“We don’t precisely know the answer, but there are a couple of theories,” Ali Jaffery, an economist at CIBC, said in an interview.

There is good reason to expect a slowdown. After all, the Federal Reserve has thrown sand in the economic gears by holding its benchmark interest rate at a 22-year high to combat inflation, pushing up borrowing costs for mortgages, car loans, credit cards, and all kinds of other credit. 

Historically, when the Fed raises interest rates, the economy has fallen into a recession. Costly loans force people to pull back on spending and businesses to cut jobs.

Indeed, last year, most economists forecast a recession in 2023 that never arrived, and looks increasingly unlikely.

Many Homeowners Shielded From Rate Hikes

One of the theories for the disconnect lies with the housing market. Historically, when the Fed has raised interest rates, driving mortgage rates up, it’s put a lot of pressure on household budgets.

But this time around, many homeowners either bought houses or refinanced their home loans during the pandemic, when mortgage rates were at record lows in the 2% range, or in the pre-pandemic era where rates were generally around 4%. Homeowners with low rates have been reluctant to sell their houses and trade in their loan for one at today’s average 30-year fixed mortgage rate of around 6.6%.

Renters have felt the sting of inflation as rents have risen, and potential homebuyers have been discouraged by higher mortgage rates. However, those with fixed-rate mortgages haven’t had their costs increase a single penny.

“Most households have very long mortgages and the ability to refinance so they’re fairly insulated for the most part from the direct impact of high interest rates,” Jaffery said.

Are Rates Really Restrictive?

Businesses have been insulated too. Since 2022, Fed officials have been very clear about their plans to raise interest rates and keep them high until inflation is vanquished. That’s given businesses time to adjust, Jaffery said.

It’s also possible that the Fed and other economists are wrong about how high interest rates have to get before they start dragging down the economy. While the Fed believes interest rates are currently “restrictive” to the economy, that may not actually be true, Jaffery said.

“The interest rate increases that we’ve seen may not be putting as much pressure on the economy,” he said.

A Virtuous Circle

There’s also a more basic explanation: People have kept on ramping up spending, creating a cycle that is a recipe for economic growth as long as inflation continues on its recent downward trajectory.

“There is a perpetual motion machine at work here that’s so simple, maybe you have to have a Ph.D. not to see it,” said Jared Bernstein, chair of the White House’s Council of Economic Advisers.

“If you have really strong job data and easing inflationary pressures, real wages start to rise. That is, wages are growing faster than prices and have been doing so for the last 10 months or so,” he explained. “So that’s not a blip. That’s a trend. When the American consumer has a strong job market tailwind at her back, that helps to power growth.”