Why we keep underestimating the strength of this economy

Job growth in February came in a lot higher than expected (311,000 jobs, compared with a forecast of about 223,000). If that phrasing sounds familiar, that’s because it happened the previous month, too. And the month before that. And the month before that.

In fact, for 11 consecutive months now, hiring has beat consensus Wall Street forecasts. Which is pretty unusual. Look, forecasting is always hard, and numbers rarely come in exactly as predicted, but it’s surprising that month after month, the experts keep getting it wrong in the exact same direction. That is, they’re always too pessimistic.

To be clear, there was good reason to have expected, month after month, a slowdown in key economic indicators such as hiring. After all, the Federal Reserve has raised interest rates eight times in the past year with the explicit goal of cooling the hot economy, to get inflation back down to more normal levels. For months, economists and politicians have warned these rate hikes might not just drag on the economic recovery — they might cause a recession.

Yet (thankfully), recession still hasn’t materialized. Like Godot, it’s always just around the corner. Why, though, does almost everyone keep underestimating the strength of the economy? Or put another way, why has the economy remained so hot, despite all those rate hikes?

The answer isn’t that forecasters are a bunch of negative Nellies, or right-wing partisans downplaying the economy’s strength (to make President Joe Biden look bad, or whatever the conspiracy theory might be). Wall Street forecasters are definitely trying to predict the numbers correctly, so they can make money.

A few possible explanations: 1) Maybe something weird has been happening with the numbers, and our measurements are off.

I don’t mean that anyone is cooking the books. Rather, response rates to the government surveys used to calculate key economic metrics have plummeted. That might skew the numbers in ways that are hard to account for upfront, and lead to bigger revisions to data later on.

Or, maybe we’re not paying attention to the right numbers. For example, there have been recent problems in the banking sector, which might not be reflected yet in federal data on jobs or consumer spending. Other, “softer” measures of the economy, such as consumer sentiment, also look quite negative.

2) Maybe monetary policy operates with longer lags than expected, and we’ll see the effects of those interest rate hikes a little further on. The housing market, among the most interestrate-sensitive sectors of the economy, has already been declining; perhaps other sectors will follow. (Though, curiously, construction firms continue to add workers, another puzzle I’ll get to in a moment.)

3) We don’t know what the economy would have looked like in the absence of all those Fed rate hikes. Maybe things would have been booming even more. So perhaps the Fed has already been slowing things down quite a bit — it’s just not terribly obvious because we’re comparing current conditions to the wrong alternative scenario (“counterfactual,” in geekspeak).

4) Maybe fiscal policy — i.e., spending and tax decisions — is continuing to stimulate the economy more than economists had expected or understood. That could be counteracting some of the things the Fed has been doing.

The conventional wisdom is that fiscal policy is, if anything, dragging on the economy right now. Which makes sense: Federal stimulus checks, the expanded child tax credit and other emergency COVID-19 programs that boosted consumer spending are for the most part in the rearview mirror. But remember, the feds aren’t the only ones making significant tax-and-spending decisions.

Virtually every state has cut taxes in the past two years. About half the states are now considering further tax cuts. These state tax cuts were enabled partly by the strong economy and partly by generous, deficit-financed funding from the federal government (such as Biden’s American Rescue Plan). States are flush, and rather than holding on to their surpluses for a rainy day, many of them are doling out cash to residents.

Who might just spend it. Because the available data on state-level fiscal decisions aren’t great, economists might not be paying sufficient attention to how they affect the broader economy.

Also: Even at the federal level, a lot of spending from industrial policy programs (infrastructure, climate, semiconductor subsidies) is coming down the pike. It’s early, so those programs likely haven’t been particularly stimulative yet. But some economists have suggested that one reason the construction sector is continuing to add workers, despite the softening housing market, might be that employers expect to be competing with government contractors for labor pretty soon.

5) COVID’S effects are weird and wild and hard to understand.

We haven’t been through anything like the recent pandemic in a long, long time, and never in a tightly interconnected global economy that looks like this one. Even the experts don’t have great precedents or models to base their predictions on.

Maybe everyone’s erring on the side of being a bit more conservative — and stingy with their optimism.