The U.S. Economy In 2023: Walking The Tightrope To Avoid Stagflation (2023)

Two years ago, I subtitled my yearly forecast of the economy “We Are All Super-Keynesians Now.” Last year it was “All Eyes On Inflation.” This year the focus is on the adjustment costs of reducing inflation. The progression of titles follows economic logic and principles: government overspends, pays for its spending by printing money or by debt monetization, prices rise, then, unless you want to end up like Argentina, you have to reverse course.

From 2018 to 2020, consolidated government spending in the U.S. grew from just over 35% to almost 48% of GDP. In 2022 it went down to 42%. From 2018 to the beginning of 2022, the money supply, measured by M2, grew from almost $14 trillion to nearly $21.5 trillion. It continued to grow until late March when it reached $21.7 trillion. It then began to contract gradually, down to $21.65 trillion at the end of August. It stands today at $21.35 trillion, less than 1% lower than the beginning of the year.

The increase in the money supply led to a spike in inflation in 2022. If today we see a slowdown in the rate of growth of inflation, it has to do with this contraction in the money supply. It has nothing to do with the “Inflation Reduction Act,” which is more focused on spending priorities than reducing the deficit. Two good ways to reduce inflation are to stop printing money to finance government spending and to liberalize the economy to increase the supply of goods in relation to the money supply.

Interest rates have also crept up. In the medium and long run, interest rates have three components: pure interest, risk, and inflationary premium. Pure interest is based on time-preference. People typically prefer to have a certain amount of money today rather than in the future. Risk also adds to the rate: the more secure the debtor, the lower the rate. And when inflation goes up, interest rates react to the new reality. Lenders can’t recover their loans when repaid with devalued dollars. Mortgage rates have doubled since the beginning of the year. With average rates of 6.60% and 5.28% for 30- and 15-year loans, respectively, and with the expectations that the Fed will keep tightening, most real estate markets will continue to suffer.

Artificially low interest rates, like the ones experienced until recently, encourage investments that make only sense at those low rates. When interest rates return to normal levels, less profitable efforts become unsustainable. Discontinued projects create waste; the reallocation of resources takes time, and part of the capital is lost for good. This period of readjustment might lead to stagnation, recession, or depression. The severity will depend on the proportion of malinvestments to the rest of the economy. I concur with those who expect that the Fed will continue its tighter monetary policies and that the U.S. economy will grow very little in 2023.


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The fate of the U.S. economy depends primarily on domestic factors. The U.S. has one of the lowest percentages of international trade to GDP in the world. It is just 25%, but supply chains rely on that trade. Foreign commerce and the economic strength of those who buy U.S. products are also essential to export-oriented businesses. This is one of the primary contexts for the prominence of China in current economic discourse. China and the U.S. are by far the world’s two largest economies. What happens in China impacts almost every corner of the globe. U.S. trade with Chinese producers is similar to its level of trade with Canada and Mexico – just under $700 billion. I do not regard trade deficits as negative per se, but others, especially those in politics and sectors competing with Chinese producers, show concern. The trade imbalance with China is more than twice the combined trade deficit with Canada and Mexico.

Getting accurate growth data from China is complex, and I do not have any inside knowledge, so I have to go with the lower end of the consensus estimates. Still, China will likely grow faster than the world economy, between 4 and 5% versus 2-3% for the world. The change in China’s policies on containing Covid, avoiding the costly generalized lockdowns, is a positive sign for the world economy. Daniel Lacalle, a respected European analyst, thinks that China’s reopening could be especially helpful for German and French exporters. Lacalle argues that a return to more rapid growth in China is “probably the biggest stimulus on the global economy that we can expect in a very challenging year.” But in the long run, especially for Europe, Lacalle expects a decade of weak growth, less than 1%, “very subdued levels of growth but not a crisis.”

On the negative side, and beyond economic policy, there is concern about a potential invasion of Taiwan. Last year, at this time, I heard one of my favorite Russian experts, Andrey Illarionov, forecast that Putin was not going to invade Ukraine. Illarionov is not an amateur analyst – in fact, he was one of Putin’s key economic advisors from 2000 to 2005. Illarionov based his analysis on the lack of sufficient forces amassed by Russia to be successful. He was proven correct on the latter point, but he was wrong on the first point. The damage to the world economy has been and will be immense. Although it might impact fewer countries directly than the invasion of Ukraine, a Chinese invasion of Taiwan would likewise have devastating effects.

The U.S. economy will not get much of a bump from Europe. The Eurozone will likely experience higher inflation, lower growth, and more unemployment than the U.S. They are choosing to adjust more slowly. The costs and uncertainties of the war in Ukraine affect Europe much more than other regions of the world. The forecast for Germany, the largest Eurozone economy, is very similar to the average.

The next largest European economy is that of the United Kingdom. The new “conservative” government might not be able to reverse Brexit, but it is taking the country in a European direction, putting more trust in the taxman than in the liberating forces of the free economy.

Despite their greater distance from the war in Ukraine, the prospects for Latin America are not much better. The economies of Brazil and Mexico make up approximately two-thirds of the regional economy, and both expect modest growth of close to one percent. Despite its potential, Mexico seems stuck in a left-wing ideology with various flavors of populism. That, coupled with the strength of drug cartels, powerful crony capitalists, and ineffective political opposition, presages that Mexico’s economy will continue to disappoint.

They will be walking a different type of tightrope in Brazil, the largest economy in Latin America and one of the largest in the world. One of the most challenging but outstanding tenures for an economic minister has come to an end – Paulo Guedes served from January 1, 2019, until today. In an administration that saw few ministers complete the entire term, Guedes was able to navigate the turbulent waters like few ministers in history. He held his own by the rudder of the economic principles and policies that, wherever tried, have led to prosperity. Guedes had to adapt to the storms coming his way, storms generated by institutional weaknesses and corporatist power. In a previous article, I wrote positively about Guedes’s deregulation efforts. Local pro-free-market economists praised Guedes for transferring economic activities from the bloated public sector to the private sector and for a sizeable improvement in the financial health of the companies that remained in state hands. Brazil achieved records in foreign trade, and the continuation of Guedes’s policies could have propelled this country to a new flourishing era. But a significant portion of Brazilian voters and an activist Supreme Court helped liberate Lula from prison and elect him as President. Lula will likely reverse economic policies and return Brazil to its usual status as a permanent promise. Brazil’s importance in Latin America is such that it deserves a separate article, not just these few lines.

I expect that in this publication and in other business-oriented media outlets, economists throughout 2023 will discuss whether the Fed’s policies are too tight or too loose. No one can know with certainty. In goods provided by the market in areas where there is less government intervention, say the production of tomatoes, we seldom ask, “what is the right amount of tomatoes?” If there is too much supply in relation to demand, the price goes down; if it is too little, the price goes up. With the money supply, though, we ask such questions continually. Now that money has become an instrument of governments and not only of market demands, we have political demands and a dual mandate for the monetary authorities, keeping inflation and unemployment low. It is impossible to know before the fact whether one is acting too slowly or too fast. That is why noted economists, such as Milton Friedman or John Taylor, have proposed rules to give better guides to markets. F.A. Hayek went further, proposing a more substantial reliance on markets by denationalizing money and increasing monetary competition.

As someone who lived the first three decades of his life in Argentina, a country destroyed by inflation, I am glad that most economists in the United States seem to shun the failed remedy of price controls. Inflation is bad but combating it with price controls creates even more significant problems. Inflation is higher today than when President Nixon imposed wage and price controls; however, economists and politicians still remember the failure of his policies and seem opposed to repeating the mistake. To be successful when walking on a tightrope, one has to go slowly. We will likely be stuck with a stagnant, slow-growing economy, but I see no other option in the current political-economic climate.

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