I spilled a lot of ink reviewing 2023 and looking ahead to 2024—see here. But I didn’t fully address one question: Where did the recession go? 

This time last year, the consensus was that the U.S. economy would slip into a recession in 2023. Heck, I was on “recession watch” a year ago, too.

And yet, in 2023 we added $500 billion to gross domestic product (GDP) in the first nine months, the unemployment rate never rose above 4%, and inflation (measured by the consumer price index or CPI) dropped from 6.4% to 3.4%.

It simply doesn’t get much better than that. So, where did the recession go? Or, asked differently, what did everyone miss a year ago?

Let’s be realistic; no one has a crystal ball. Still, several factors contributed to the egregious, collective miss on the economy.

For one, forecasters give the Fed too much credit and rely too heavily on textbook relationships. Additionally, the recency bias and reliance on small data sets led forecasters astray. And the post-COVID economic data is still noisy, which didn’t make analysis any easier.

Here’s my take on some of the most misleading factors:

Physics Envy

Economists suffer from what I call “physics envy.”

In a laboratory, specific rules apply. You know that if you do X, then Y will happen … every single time. The economy doesn’t work that way. If the Fed raises interest rates by 1%, that doesn’t automatically lead to, say, a 0.5% decline in inflation. (If only it were so straightforward.)

The textbooks say you must push the unemployment rate up to bring inflation down. The harsh reality is that people spend less when they aren’t earning a paycheck. So, if you want inflation to come down, people must lose their jobs … or so the theory goes.

This economic theory, the Phillips Curve, is based on a graph comparing unemployment and inflation. What the theory misses is that employment is not the only factor determining inflation. Supply chains matter, too.

The New York branch of the Federal Reserve calculates a global supply chain pressure index. It combines the cost of transporting with various measures of manufacturing to gauge the condition of the worldwide supply chain. I’ve plotted it below against annual inflation.

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