Quarterly Review and Outlook Third Quarter 2023

Impending Recession

The long history of business cycles illustrates that rising inflation precedes recessions. Inflation accelerations don’t just happen, they are caused. Accordingly, a more complete description of these aggregate fluctuations is that monetary accelerations precede rising inflation, which then requires monetary decelerations that inevitably lead to recessions. Thus, monetary policy actions are pro- rather than counter-cyclical and the financial cycle will continue to lead the GDP and price/labor cycle.

The process of the monetary policy reversal from the 2020-22 inflation is presently at an advanced stage, suggesting a repeat of the standard business cycle process. To be sure, the quick spread of inflation in this cycle was abetted by massive fiscal stimulus via transfer payments along with the central bank’s dramatic balance sheet expansion. These combined monetary and fiscal actions have resulted in negative net national savings, a condition that will impair economic growth well after the Fed reverses the severe monetary restraint currently in place. Indeed, the coming downturn may send net national savings even more deeply negative.


As a result of the Fed’s engineered reduction in permanent reserves of the depository institutions of $1.0 trillion from the peak in early 2022, other deposit liabilities (ODL) have fallen by $1.5 trillion. The fall in ODL is important because it leads to bank credit implying further deterioration in bank credit. Since 2020, the de facto deposit multiplier averaged 2.0 meaning that for each one-dollar loss in this reserve measure, ODL fell two dollars. Further evidence of monetary restraint is that the real Federal funds rate in September rose to the highest level since 2007. Here, the real Federal funds rate is calculated as the nominal rate less one-year inflationary expectations in the University of Michigan consumer sentiment index. Likewise, real ODL (deflated using CPI) decreased over the latest 12-, 24- and 36-month intervals, resulting in an unprecedented swing from acceleration to contraction. This is the same type of central bank reaction that has repeatedly exacerbated business cycle swings, as was so carefully documented by Nobel Laureate Milton Friedman and reinforced by the scholarly work of John Taylor of Stanford University. Thus, in responding to one crisis the Fed has created another crisis, which is a process of booming the booms and slumping the slumps.

Real Median Household Income

Chart 1

Real Average Weekly Earnings Full Time Wage and Salary Workers

Chart 2

The Pandemic response of both fiscal and monetary policymakers caused the inflation rate to accelerate from a trend rate of increase of about 2% in the 2010s to slightly over 9% in 2022. The rapid inflation affects everyone but the greatest burden falls upon the modest and low-income households. U.S. inflation-adjusted median household income fell 4.7% from 2019 to 2022, bringing it back to 2018’s level (Chart 1). Real average weekly earnings of salaried and full-time hourly workers (approximately 120 million Americans) fell at a 2.4% annual rate over the latest twelve quarters (Chart 2). These income measures demonstrate the depth of the damage caused by the inflationary surge as well as the severe impact to the middle of the income spectrum. As a consequence of these income losses, housing affordability is at multi-decade lows and Cox Automotive calculates that new cars are so expensive that they are not affordable for one-half of the households.