In the final week of 2022, we Americans can foresee two significant economic risks in 2023. The first one is a probability that the Federal Reserve will get weak-kneed and stop raising interest rates before inflation is truly under control. The second risk is that Congress will continue to spend and borrow money irresponsibly. The likely mix of these two hazards would all but ensure that our economic misery lasts much longer than necessary.
Let's start with the first risk. In theory, to tame inflation, the Fed will need to push real interest rates not only high—as it has already done—but higher than the highest rate that the Fed is now targeting, and in fact much higher than most investors can remember. Such high rates will have two main effects: popping the stock market and real estate market, along with any other asset bubbles that we've witnessed in recent years. The economic downturn that would follow would increase unemployment rates significantly.
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