Kelley School economic forecast underscores uncertainty for 2023

BLOOMINGTON — The Indiana University Kelley School of Business released its annual Business Outlook forecast on Thursday, and uncertainty is the primary highlight heading into 2023.

“I’ve been part of this for 25 years at the Kelley School, and this is one of the hardest years we’ve found to actually make a prediction,” said Phil Powell, academic director of the Indiana Business Research Center at the school.

IU said output growth will at best be weak next year, and there is a strong possibility of negative growth for part of the year.

In an interview with Inside INdiana Business, Powell said the forecast is split between two predictions, one optimistic and one pessimistic.

“The optimistic scenario is very weak growth of about 1% in the country where unemployment goes up a little bit–less than a point–and it peaks about mid-year,” said Powell. “The pessimistic scenario is that the economy contracts for at least two quarters at an annual rate of more than 2%, and that the unemployment rate instead of going up less than a point, it goes up about two, two-and-a-half points. That would mean a loss of 3 million jobs in the country. It would not be a catastrophic year, but it would be a year of struggle and economic retrenchment.”

Powell said the biggest driver of the economic uncertainty in 2023 is the aggressive increasing of interest rates by the Federal Reserve, which has not been seen since the late 1970s and early 1980s.

“As an economy, we’re not used to operating in this kind of environment. And so the question is as capital becomes very expensive very quickly, how fast do businesses just put on the brakes and stop investing, stop placing orders, which then rolls into layoffs and business slowdown? How are business going to react to that when they haven’t experienced high inflation and high interest rates in over 40 years?”

The Kelley School said total output has grown by just 1.8% over the past four economic quarters, with consumer spending, business investment, housing construction and government purchases all being “significantly weaker” than what was expected a year ago.

Powell said there’s not much the government can do in the short-term aside from making sure that the country’s social safety net–unemployment benefits and other forms of social assistance–is well funded.

He said the only way to bring down high inflation is to reduce demand in the markets.

“Unfortunately, because this is inflation caused by a lot of issues of energy and supply chains and shortage of labor, there’s nothing that can be done this year. We sort of have to go through this pain in order for the economy to sort of right itself and get to a sustainable level, which is really kind of getting back to a new normal after all of the shocks and all of the uncertainties caused by the pandemic.”

IU said spending on consumer goods in the third quarter of 2022 was 15.2% higher than pre-pandemic levels, while services were only up just 3.4%. Powell said if consumer spending continues to be higher, that could help the country achieve the optimistic scenario of the forecast and keep the economy level.

If consumer spending narrows, that could not only lead toward the pessimistic scenario, but also have a larger effect on Indiana, where the economy remains reliant on durable goods manufacturing that accounts for 16% of the state’s gross domestic product.

“The good news is that Indiana is typically in a little bit better position than the rest of the country,” Powell said. “Where we are most vulnerable is in manufacturing, and that’s where we see the biggest risk in terms of state economy relative to the rest of the nation. If you’re a Hoosier, you want American households to keep spending their money because if they can keep spending it, that will smooth out demand and spending over time, and it will allow us to have a soft landing from this dramatic increase in interest rates.”

IU said other risks to the forecast include the international impact of the ongoing war in Ukraine, how central banks in developed countries handle their fiscal policies and tightening financial conditions as interest rates rise.

The full report on the outlook for 2023 will be published in the winter issue of the Indiana Business Review, which will be available online next month.

The Kelley School presented the forecast Thursday in Bloomington and plans to present it in eight other cities throughout the state beginning on Monday in Columbus at The Commons.