Economists at the Federal Reserve predicted that a mild recession would hit the United States in the second half of 2023.
The Federal Open Market Committee and the Federal Reserve Board of Governors concluded in a meeting last month that recent turmoil in the financial system warrants a recession forecast for the end of the year, followed by a recovery over the course of the subsequent two years, according to minutes released on Wednesday. Policymakers also estimated that the historically low unemployment rate will rise toward the beginning of next year.
“If the effects of the recent developments in the banking sector on macroeconomic conditions were to abate quickly, then the risks around the baseline would be tilted to the upside for both economic activity and inflation,” the minutes said. “If banking and financial conditions and their effects on macroeconomic conditions were to deteriorate more than assumed in the baseline, then the risks around the baseline would be skewed to the downside for both economic activity and inflation, particularly because historical recessions related to financial market problems tend to be more severe and persistent than average recessions.”
Fears of a contraction have persisted over the past two years as inflationary pressures and supply chain bottlenecks threatened recovery from the lockdown-induced recession. Federal Reserve officials have repeatedly increased the target federal funds rate from near-zero levels in order to combat record inflation, moves which posed the risk of slowing the economy as consumers and businesses face higher borrowing costs.
The difficult macroeconomic environment previously led most economists to forecast a recession for this year, although some predicted the United States could avoid a contraction. Bank of America Chief Investment Strategist Michael Hartnett said in a report that a recession would occur in the first half of the year before markets attain a “much more solid footing,” while an outlook from Goldman Sachs Chief Economist Jan Hatzius noted analysts at the company believe “there are strong reasons to expect positive growth in coming quarters.”
Economic risks worsened last month when Silicon Valley Bank collapsed as the company sold long-term government securities and corporate bonds at a loss to fund withdrawals, causing the firm to realize heavy losses due to the higher rates and leading to the company’s unexpected implosion. Signature Bank collapsed days later as account holders worried about the availability of their balances rushed to withdraw funds.
Assets in the overall banking system are now $2 trillion lower than their book value due to the elevated interest rates, according to a study from analysts at the National Bureau of Economic Research, prompting worries about the stability of the sector.
The vast majority of clients at both financial institutions had balances exceeding the $250,000 threshold covered by the Federal Deposit Insurance Corporation. Officials at the Treasury Department and Federal Reserve scrambled to protect all deposits at the two firms, even those which surpassed the threshold, in order to mitigate the risk of bank runs elsewhere.
The release of the dire prediction from Federal Reserve officials comes after Treasury Secretary Janet Yellen asserted on Tuesday that she is “not anticipating a downturn in the economy, although of course that remains a risk.” President Joe Biden claimed on Wednesday that his policies created a “more dynamic economy for the long haul.”