Thomas S. Nesslein
Ph.D. – Associate Professor, Cofrin School of Business – University of Wisconsin – Green Bay
Let us begin by clearly noting the difference between inflation, that is, the general increase in the price level over time from the rise in prices of specific goods that may be significantly outpacing increases in the general price level. Clearly, consumers were much aware and distraught over the general inflation of 8 percent in 2022. However, they are probably even more aware and angry in recent years about the sharp increase in beef prices, egg prices, auto prices (both new and used), and most of all, housing prices which have jumped some 50 percent since 2020. It is important to note here that these specific product price increases have been driven by specific supply factors impacting these goods. Consequently, in the short run fiscal and monetary policy policies have almost no ability to improve the supply conditions for these goods, thus reducing their price.
Now with respect to general inflation, both fiscal and monetary policy may have an impact, but the impact varies. Very clearly, the massive increase in federal government spending in the Covid years of 2020 and 2021 was by far the key driver of the high inflation at 8 percent in 2022, especially when one accounts for Keynesian multiplier effects. Then inflation moderated in 2023 and 2024 as federal spending fell sharply from the peak year 2021. A sharply more restrictive monetary policy began March 2022 from a near zero federal funds rate to a rate over 4% by the end of 2022. This monetary restraint certainly helped to slow down inflation although federal spending was also more restrained. The core inflation rate which the Fed favors as a policy guide since it excludes volatile costs, namely, food and energy, has trended down from 2021, 5.5 percent, to 2.9 percent through August, 2025. What then is the future? Will the inflation rate continue down towards the Fed’s goal of 2 percent or will the trend be up?
Now some may believe a key factor is the broad and significant tariff policy in place for some six months now. Clearly, tariffs which are a tax on consumer goods and producer inputs will raise prices to a higher level. However, a one-time increase of, say, 25 percent, while not good, does not lead to a 25 percent inflation rate over time. Indeed, tariffs are clearly inefficient and will lead in the long run to a slowing of economic growth.
A key argument advanced by many commentators is that official unemployment rate (U – 3) has held very steady in 2025 with rates of around 4.2 percent. Consequently, they argue that the economy remains at “full employment”. Concomitantly, consumer spending (two-thirds) of total spending is likely to continue its robust growth. Therefore, these commentators suggest that the economy is quite well with no recession in sight.
I argue, however, that troubling signs exist concerning the health of the economy. Indeed, I believe that the U.S. economy is heading towards recession in the near future. First, good reasons exist for believing that the official unemployment rate (U – 3) is disguising major problems in the labor market. The U – 3 rate has been around 4.0 percent whereas a broader measure of unemployment (U – 6) has been about 8.0 percent for more than two years. This broader measure counts not only total unemployed (U – 3) but also discouraged workers who have given up seeking employment plus part-time workers who actually desire full-time employment. Many recent reports in the media suggest that the broader measure of unemployment at this time provides a better view of the true labor market situation.
Moreover, it seems highly unlikely that the recent strong spending in the economy can continue much longer. Reports are numerous of significant unemployment because of downsizing at major firms such as Meta, Microsoft, Intel, etc. Moreover, about 50 percent of college graduates in recent years are unable to acquire college-level jobs with salaries above $55,000. While most college educated workers can find some job, it is more in the range of $30,000 to $45,000. On top of that, most of these workers also struggle to service student loans.
Consequently, much of the average population has been meeting expenses by increases in consumer debt. When they max out on their credit cards, they are often turning to the expanding market of “buy now – pay later” installment loans. In addition, given the high price of homes and high mortgage rates, there is increasing evidence that a significant proportion of home borrowers are overleveraged and are struggling to avoid foreclosure.
Finally, another measure of economic activity long favored by Mark Skousen is gross output (G0). GO measures spending at all stages of production and is more than twice the size of GDP which is currently $30 trillion. This alternative measure of economic activity shows that recently total business spending has fallen sharply. Perhaps, this is the key reason that the payroll-processing giant ADP just reports that the U.S. lost 32,000 private sector jobs in September! In contrast, economists surveyed by the Wall Street Journalhad predicted an increase of 45,000.
In summary, a good basis exists for predicting a recession in the immediate future. The depressed spending in the economy will surely moderate increases in the overall inflation rate.
Source: Changes in Inflation by City