PIMCO’s Tiffany Wilding: Lessons from a year of unexpected economic resilience

This time last year, we were projecting a mild recession with still above-target inflation for 2023.

Our reasoning was that while pandemic-related overhangs, such as excess savings from large government transfers, would help buffer the economy, the speed and magnitude of the correlated monetary policy tightening across developed markets, combined with the European energy price shock, would drag DM economies into a mild contraction.

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We did not get that mild recession. Instead, DM economies, with the exception of the US, have recorded something closer to growth stagnation, while US growth remained surprisingly robust at an above-trend pace.

Three things stand out as contributing to the better-than-expected outcomes for DM economies in 2023:

1. Restrictive monetary policy raised borrowing costs but it did not kick off a tightening in broader financial conditions, largely because central banks contained the impact of events that could have threatened financial stability.

The flipside of businesses and consumers terming out their debt with post-pandemic low-interest loans is increased interest rate risk being held by banks and other non-bank financiers.

However, stress caused by the market value losses on these loans – banking sector stress in the US and Europe in particular – was arrested by swift government interventions, limiting the spillovers into the real economy.

2. This containment, plus elevated real household savings buffers and some additional support from a surprise widening in the US deficit, eased erosion of private sector business health.

Resilient real and nominal growth, as consumers spent down their buffers, supported corporate margins and broader balance sheets in particular.

3. Finally, better-than-expected supply-side developments moderated inflation despite the resilient demand.

Many global supply bottlenecks finally resolved, the US multifamily housing sector is experiencing some supply hangover from a post-pandemic building boom, and – judging from Chinese producer price deflation – factory capacity in the largest global manufacturing hub is once again abundant.

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Labour markets have also shown signs of easing, as supply has recovered – labour force participation rates are now above their pre-pandemic levels in many countries. 

Despite these developments that bolstered economies in 2023, the risk of a downturn in 2024 remains high.

Real savings buffers should soon return to pre-pandemic levels, fiscal policy will likely be mildly contractionary and the economic drag from higher borrowing costs will likely build – all at the same time that supply side catch-up also has run its course.

Most importantly, central banks have emphasised their intentions to keep policy rates restrictive for an extended period, and this runs counter to the policy easing that historically has contributed to soft landings.

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Sustained economic expansions are exceedingly rare when elevated inflation necessitated aggressive central bank policy tightening.

When such soft landings did occur, it was only after the central bank cut rates pre-emptively in the face of a positive supply shock that drove down inflation.

Hence, a key question for the 2024 outlook may be when and whether central banks will declare victory and start pre-emptively cutting rates and normalising policy.

Measures of headline and core inflation continue to decline, but with less progress in the wage-sensitive core services inflation data, along with low unemployment, central banks remain in a tricky position – tolerating some above-target inflation may be the necessary cost of sustaining the expansion.

Here, again, past experience is not on their side.

The history of rate-cutting cycles suggests that central banks have not tended to foresee economic weakness with a long enough lead time in order to pre-emptively cut rates and avoid a recession.

Instead, they have tended to start cutting coincident with the unemployment rate ratcheting up and the output gap falling into deep contraction.

Of course, history does not repeat, but it often rhymes.

Tiffany Wilding is managing director and economist at PIMCO