Relative strength of the state's economy is owing to strong construction sector, sufficient rainy-day fund and increasing demand for defense goods, software

LOS ANGELES, March 15, 2023 /PRNewswire/ -- As 2022 drew to a close, the UCLA Anderson Forecast's final report of the year described an economy at a crossroads. The Federal Reserve was contemplating different inflation-fighting strategies that might slow but not stall inflation or, depending on how aggressively the Fed acted, trigger a mild recession.

To simplify an admittedly complicated set of actions, the more aggressively the Fed raises interest rates to combat inflation, the likelier a recession becomes.

Now, approaching the second quarter of 2023, the UCLA Anderson Forecast again presents a two-scenario approach for the national economy. One scenario is no recession: Economic growth slows but remains positive, inflation ebbs, labor markets remain robust and the Federal Reserve takes a less aggressive approach to monetary policy tightening.

The second scenario is a recession that occurs toward the end of the year because the Federal Reserve took aggressive inflation-fighting actions. In the latter scenario, the Fed forces a mild recession and accepts an economic contraction and higher unemployment to combat inflation.

The difference between the two scenarios is how the Federal Reserve sets monetary policy. The Fed has said it will be data-dependent. If data show that the labor market remains robust but inflation remains persistent, the Fed will likely err on the side of tightening monetary policy more aggressively.

Three months ago, UCLA Anderson's forecast for California also featured two scenarios because of a lack of clarity regarding the vagaries of national economic policies. For the current forecast, national economic policy is again the source of uncertainty about California's economic outlook, so the Forecast again presents two scenarios.

In the coming months, the Fed will choose between continued aggressive monetary tightening and moderation, and that choice will affect the California economy. The good news is that unlike during the past four economic slowdowns, the Forecast calls for a milder impact on California's economy no matter which path the Fed decides to take.

The national forecast

According to the UCLA Anderson Forecast report, the trajectory of the economy is too uncertain simply to present an average of two divergent possibilities. It notes that the economy continued expanding in the fourth quarter of last year, even though many economists thought a recession would already have begun, given the aggressive pace of monetary tightening.

According to the March report, the majority of U.S. consumers believed the country was in a recession throughout most of 2022, even though the economy continued to grow and add jobs, and even though consumers themselves continued to spend. The report notes that even the rapper Cardi B tweeted on June 5, 2022, "When y'all think they going to announce we going into a recession?"

Regarding the presence of a recession, the March report is emphatic: "We are not currently in a recession, and if any recession does occur, it will only begin toward the end of 2023, with the important caveat that the U.S. economy might avoid a recession altogether throughout our forecast horizon." The current Forecast extends through the end of 2025.

As in the last quarterly forecast, the reason the Forecast is uncertain about Federal Reserve policy is that the Fed itself seems uncertain. Financial markets are now pricing in a 50-basis-point increase at the next Federal Open Market Committee meeting. In the course of just over one month, Anderson economists have gone from thinking that inflation was slowing and the Fed was close to reaching its terminal rate to realizing that faster tightening may be warranted and we may need a higher terminal rate than previously anticipated. (The terminal federal funds rate is the final interest rate that the Federal Reserve aims to achieve at the end of a monetary policy cycle of loosening or tightening.)

"While the economy has so far remained resilient to higher interest rates outside of some moderate softening in construction, that resiliency is what might lead to the recession scenario path," the report's authors write. "The more consumers continue to spend despite higher prices and higher interest rates, the more gradually demand-induced inflation will come down, and the more the Federal Reserve might be expected to tighten monetary policy to combat inflation. The 'might' here could well be mitigated by falling commodity prices and new rental lease contracts."

In both scenarios, the Forecast expects continued GDP growth in the first quarter of 2023 at a seasonally adjusted annual rate (SAAR) of 2.3%, driven by consumption and business investment. The scenarios then diverge.

In the no-recession scenario, quarterly GDP growth would slow to 1.8% SAAR in the second quarter of 2023. It would remain below 1.0% in the third and fourth quarters of 2023 and then pick up in 2024 and 2025.

In the recession scenario, the economy would contract beginning in the third quarter of 2023; the contraction would deepen in the fourth quarter of 2023 and the first quarter of 2024, and then the economy would begin to rebound.

In both scenarios, inflation would remain elevated throughout 2023, but it would be more persistent in the recession scenario, requiring tighter monetary policy to achieve disinflation. In the no-recession scenario, the Forecast assumes that supply chain pressures would ease more rapidly and therefore inflation would come down more quickly on its own, creating the rationale for a more moderate monetary policy.

In the recession scenario, the assumption is that a greater proportion of the observed inflation would be demand-driven — related to tight labor markets — and therefore inflation would continue for longer. In neither scenario do the Forecast authors expect a return to the Fed's 2.0% inflation target by the end of the forecast horizon.

The California forecast

In the event that the economy navigates a softer landing and avoids a recession, the California economy will grow faster than the national economy, according to the Forecast. Among the factors buoying the state's economy are a strong construction sector, a sufficient rainy-day fund at the state government's disposal, and an increasing demand for defense goods, labor-saving equipment and software.

In this scenario, the unemployment rate averages for 2023, 2024 and 2025 are expected to be 4.0%, 3.9% and 3.6%, respectively. Non-farm payroll jobs are expected to grow by 2.3%, 1.2% and 1.4% during the same three years. Real personal income is forecast to dip by 0.2% in 2023, and then grow by 1.7% in 2024 and 2.1% in 2025.

In spite of higher mortgage interest rates, the continued demand for a limited housing stock, coupled with new laws permitting accessory dwelling units to be built in neighborhoods zoned for single family homes, leads to a forecast of increased homebuilding through 2025. The Forecast projects that the number of housing permits will grow to 150,000 in 2025.

In the recession scenario, the California economy would decline, but by less proportionally than that of the nation. In this scenario, the unemployment rates for 2023, 2024 and 2025 are expected to be 4.3%, 4.8% and 3.7%, respectively. Non-farm payroll jobs are expected to grow by 1.1% in 2023, contract by 1.2% in 2024 and grow by 0.9% in 2025. Real personal income is forecast to decline by 0.4% in 2023, then rise by 1.3% in 2024 and by 2.5% in 2025. The economists forecast 92,000 net new housing units to be permitted in 2023, growing to 152,000 permits in 2025.

About UCLA Anderson Forecast

UCLA Anderson Forecast is one of the most widely watched and often-cited economic outlooks for California and the nation and was unique in predicting both the seriousness of the early-1990s downturn in California and the strength of the state's rebound since 1993. The Forecast was credited as the first major U.S. economic forecasting group to call the recession of 2001 and, in March 2020, it was the first to declare that the recession caused by the COVID-19 pandemic had already begun.
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About UCLA Anderson School of Management

UCLA Anderson School of Management is among the leading business schools in the world, with faculty members globally renowned for their teaching excellence and research in advancing management thinking. Located in Los Angeles, gateway to the growing economies of Latin America and Asia and a city that personifies innovation in a diverse range of endeavors, UCLA Anderson's MBA, Fully Employed MBA, Executive MBA, UCLA-NUS Executive MBA, Master of Financial Engineering, Master of Science in Business Analytics, doctoral and executive education programs embody the school's Think in the Next ethos. Annually, some 1,800 students are trained to be global leaders seeking the business models and community solutions of tomorrow.

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SOURCE UCLA Anderson Forecast