Key Themes and Takeaways
  • The Federal Reserve’s most recent economic forecasts predict a year of solid growth, a continued strong labor market, and stubborn inflation.
  • Despite the strong economy, the Fed may still opt to lower interest rates slowly over time.
  • The economy has momentum, but uncertainty remains high and realistic scenarios for the year remain broad. Diverse outcomes for the economy will likely have varied impacts on workers compensation.

Economic Outlook

2024 Economic Forecasts From the Fed’s Perspective

Some of the most important economists (and a few non-economists) to follow are the members of the Federal Open Market Committee (FOMC). The FOMC is comprised of the Board of Governors of the Federal Reserve System (the Fed) and a rotating subset of presidents of the regional Federal Reserve Banks. This group of individuals meets eight times per year and sets monetary policy through changes in the level of the federal funds rate—the benchmark interest rate in the economy—as well as other tools to promote financial stability and to achieve their dual mandate of full employment and stable prices. Four times per year, the FOMC publishes a Summary of Economic Projections (SEP), highlighting the committee members’ forecasts. In these SEPs, the members apply their own individual assumptions about the appropriate path of monetary policy and forecast how the economy will respond. Forecasts include changes in real GDP growth, the unemployment rate, inflation, and the level of interest rates.

Historically, the Fed has not been meaningfully better or worse than other forecasters at predicting economic outcomes, but their forecasts carry more importance because the committee sets monetary policy based on their own expectations. In this paper, we will assess the Fed’s forecasts for the economy in 2024, look at a few potential scenarios where things could look different, and discuss the likely implications for workers compensation.

What Is the Fed Telling Us Will Happen in 2024?

Before getting into the 2024 forecasts from the latest SEP, let’s first take a look at the longer-run forecasts. These are basically the Fed’s estimates of what the economy would look like under optimally balanced conditions:

The central tendency of FOMC members (removing the three highest and lowest forecasts) for a balanced economy is real GDP growth of just below 2%, unemployment near 4%, inflation at the 2% target, and the benchmark interest rate between 2.5% and 3%. In 2023, the economy grew 3.1%, unemployment averaged 3.6%, core PCE inflation (the Fed’s preferred measure) grew 2.9%, and interest rates ended the year in a 5.25% to 5.5% range. As you can see, economic results are not exactly in line with those targets.

The Fed’s main lever to influence the economy is through the level of the benchmark interest rate. Generally, interest rates support or restrict economic growth by changing the cost of borrowing money. When inflation soared in 2022, the Fed embarked on the fastest increase in interest rates since the early 1980s—which is not-so-coincidentally also the last time the economy saw inflation as high as in 2022. The Fed has and will continue to assert that monetary policy works with long and variable lags, so it should not be surprising that the Fed also expects it to take a few years before the economy starts to look more like their longer-run forecasts.

In 2024, the Fed expects economic growth to slow from 2023 but remain above the longer-run estimate of potential growth, in a range of 2% to 2.4%. The unemployment rate is expected to move up slightly from current levels to around 4% and inflation is expected to continue to make slow progress towards the 2% target. Under this scenario, payroll and premium growth would likely continue to slow from a combination of slower employment growth and softer wage growth. Note that due to expected labor force growth—prompted by a slow but still growing population and increased participation—employment levels should increase even with a slight uptick in the unemployment rate.

Despite the Fed not expecting inflation to sustainably hit their target until 2025 at the earliest, interest rates are forecasted to slowly decline from their current levels, with the first cuts expected in 2024. Why would the Fed begin cutting rates this year if they think we are still at least two years from sustainably hitting their inflation target? The economy responds to interest rates in real terms (adjusted for inflation), not nominal terms (the current level).Measuring the Natural Rate of Interest, Thomas Laubach and John C. Williams, Board of Governors of the Federal Reserve System, November 2001. As inflation falls, if nominal interest rates remain unchanged, then real interest rates would rise and become more restrictive on the economy. The Fed is looking to maintain a steady level of restrictiveness to move the economy softly into balance rather than become increasingly restrictive and risk a hard landing.“Fed's Powell says restrictive rates policy needs more time to work,” Howard Schneider and Ann Saphir, Reuters, April 16, 2024. Recent economic data, however, risks the Fed reassessing the current projected path of interest rates over the year. If economic data, importantly labor market and inflation data, remains strong, the Fed may opt for fewer cuts or no cuts at all in 2024.

What If the Fed Is Wrong? How Different Might Things Look?

As forecasting is just a fancy scientific term for fortune-telling, forecasters, including the Fed, are bound to be wrong from time to time. With economic forecasting in particular, you should expect the Fed, and any other forecaster really, to be wrong more often than right. In simple terms, it is because our economy is subject to the whims of fickle consumers and is frequently bombarded by exogenous (unpredictable) shocks. While we think the Fed’s baseline scenario is a reasonable possibility, here are a few alternative scenarios that could play out, including what is likely to cause them if they occur and what that could mean for workers compensation.

Scenario A: The Economy Slows More Than Expected

Ever since the Fed began raising interest rates in early 2022, some forecasters have been predicting dire consequences for the economy. So far, very few of the predicted implications have come to fruition. For the sake of argument, however, let’s consider the Fed’s assertation that monetary policy works with long and variable lags. What could things look like if the actions already taken lead to a more sizable slowing than has shown up in the data so far?

Consumer spending accounts for roughly 70% of economic activity and seems like the logical place to start. In a previous Quarterly Economics Briefing,“Economic Outlook for Q2 2023,” Quarterly Economics Briefing, Patrick Coate and Yariv Fadlon, ncci.com, July 24, 2023. we wrote about the state of consumer finances. On average, consumers accumulated excess savings during the pandemic and subsequently spent down most of those savings to support on-trend consumption levels despite above-average inflation, fueling economic growth. We then furthered the story in a follow-up Quarterly Economics Briefing“Economic Outlook for Q3 2023,” Quarterly Economics Briefing, Stephen Cooper, Yariv Fadlon, and Patrick Coate, ncci.com, October 26, 2023. by layering in increasing credit card utilization by consumers to further smooth spending as excess savings began to diminish. While we still see consumers as holding up relatively well, especially as recent wage growth once again outpaces inflation, one big potential risk to the economy is consumers finally running out of steam and cutting back on spending. Let’s explore that thread.

In this theoretical scenario in which consumer finances deteriorate and households cut their spending, the economy would likely see growth slow to near 0%. It could even dip slightly and become negative as households readjusted their spending and savings. Lower levels of spending could ripple through the economy because businesses would have to simultaneously become more competitive on prices to drive revenue growth while cutting back on costs to preserve profitability. As such, inflation should decelerate faster but employment growth could slow even further or reverse altogether. In this traditional end-of-business-cycle type scenario, the Fed would have latitude to quickly lower interest rates and move policy to a more accommodating stance.

The most immediate implication for workers compensation would be reduced premium growth. Payroll growth would likely slow significantly due to flattening or even negative employment growth. Wage growth would likely slow by less, but any slowing would also put downward pressure on payroll growth. As seen in prior slowdowns or recessions,“How Do Recessions Affect Workers Compensation?” Quarterly Economics Briefing, Patrick Coate, ncci.com, October 16, 2019. consolidation in the labor market can have benefits for injury patterns because companies are likely to retain their most skilled and productive workers, while reduced hiring lowers the share of short-tenured workers in the labor force. In downturns, however, any benefits to injury patterns are typically overshadowed by the changes in premium growth.

Scenario B: The Economy Continues to Stay Hot

In 2023, the economy defied all expectations to grow 3.1%. Could it happen again? Could we even see growth outpace 2023? Remote work, generative AI, automation, and other factors have been cited as potential reasons for short-term productivity gains during the pandemic recovery. While the jury is still out on whether these factors are sustainable, let’s explore what things could look like if they or other factors lead to a sustained boost in productivity. The economy would quickly be teleported back to the late 1990s and early 2000s, when advances in computing technology and the rise of the Internet provided the most recent productivity boom.

During that time period, economic growth averaged closer to 3% than the 2% we’ve seen over the past 15 years. Productivity growth would likely not only boost economic growth but would also sustainably boost wage growth because workers might be paid more for higher levels of output. Employment growth would remain high as the economy continued to expand, and the labor market would likely remain tight as the demand for more workers would exceed the rate of population growth. Higher levels of activity across the economy could keep inflation elevated and put pressure on the Fed not only to keep interest rates at their current elevated level, but potentially increase interest rates even further to prevent instability.

In this type of economy, one might be tempted to immediately jump to the conclusion that payroll and premium growth would grow at sustainably higher rates from a combination of employment and wage growth. Payroll growth would likely remain elevated, but the implications for premium growth are less clear-cut. Productivity gains through remote work, AI, and automation all make work safer. Gains from these channels could accelerate shifts in the labor force as even more routine manual and cognitive tasks get automated, leading to more jobs and higher wages being paid in lower loss cost industries. Another confounding factor for the frequency picture is the tight labor market that would likely exist under this scenario. Hiring and retaining talent could become challenging again, and in a fast-growing, dynamic economy, voluntary quits might rise again as well. While this scenario would be a good outcome in many ways, it could also bring about or speed up meaningful changes to the workers compensation industry’s priorities.

Scenario C: The Immaculate Disinflation

While the previous two scenarios contemplate what the economy could look like if things were different, this last scenario explores the implications if the pandemic didn’t permanently change things at all. Perhaps the large increase in inflation was entirely caused by pandemic-related supply chain issues and a stream of government payments to households. Then, with both of these effects largely behind us, the economy might come out the other side looking relatively similar to what it did prior to the pandemic. In this scenario, falling inflation is a result of supply chain problems easing and excess pandemic savings having largely been spent rather than a result of monetary policy.

Under this scenario, economic conditions would likely converge to their pre-pandemic trends and start to look a lot like the longer-term forecasts from the Fed: growth just below 2%, inflation moving quickly down to the 2% target, unemployment steady near 4%, and high interest rates that need to quickly be lowered back towards the longer-run forecast of 2.5%. Under these conditions, payroll growth could also quickly converge back down to its pre-pandemic trend. With the labor force back to steady and predictable growth, economic influence on frequency trends would likely fade into the background as longer-term trends in workplace safety would once again become the dominating factor for workers compensation.

Conclusion

In this paper, we have looked at the Fed’s forecast for the economy in 2024 as well as three alternative scenarios. These four potential outcomes do not in any way represent the full spectrum of possible outcomes for the economy but highlight how broad the range of possible outcomes is. These scenarios also highlight the challenge that faces policymakers at the Fed as they assess the appropriate level of interest rates without knowing which way the economy could be moving.

These scenarios also highlight the broad range of potential outcomes for workers compensation. Continued above-average premium growth, a quick convergence to the pre-pandemic trend, a more serious slowing, or an outright decline are all potential outcomes based on how the economy evolves over the next few years. Additionally, the economy’s impact on frequency trends could intensify or diminish. As incoming data throughout the year sheds light on how things are evolving, we will be analyzing each facet to determine the implications for workers compensation.