Where is the economy headed in the next year? Perhaps in this time of uncertainty politically, financially and internationally, our focus should be on the next three months, much less years in the future. At the 30th Annual Economic Forecast Conference on Oct. 24 co-presented by Cal State Fullerton’s Woods Center for Economic Analysis and Forecasting and the Orange County Business Council, CSUF economists Anil Puri and Mira Farka break down the outlook for Orange County, California, the U.S. and the world economy.

Much to the surprise of the average American, and even academics and policymakers, the U.S. economy has thus far dodged a recession while managing to get the second-highest inflation in living memory under some level of control. That feat of taming inflation while avoiding a serious downturn defies many historical norms and is a reason for the Federal Reserve to celebrate.

“It’s not just the Fed that the U.S. economy has taken by surprise,” explain Anil Puri and Mira Farka, economics professors at the Cal State Fullerton College of Business and Economics. “As it plows ahead, this expansion seems to play by its own rules, obliterating old ones along the way. Tried-and-true recession indicators have been sending spectacularly wrong recessionary signals for an alarmingly long time.”

The situation is so puzzling that even Puri and Farka feel it is unprecedented in their decades of economic forecasting and makes understanding where we’re headed even more challenging than usual.

“We are somewhat bewildered both by the wild swings in sentiment and the Fed’s aggressive move to cut interest rates,” they say. “An economy that is growing at a 3.1% rate cannot also simultaneously be on the brink of a recession and in desperate need of an oversized rate cut.

“Our view is that this time the Fed will likely pull off half of the soft-landing prophecy: avoiding a recession. The other half — on-target inflation — will be a bit more elusive and harder to deliver. We call this a soft-landing with an asterisk.”

An elevated, sticky inflation means that interest rates will remain higher than what the consensus expects. Service inflation – the rising cost of services such as haircuts and dental work and home contracting – is the toughest to get under control. This is driven both by housing costs and by higher wages which is the reason why many services, including insurance and car maintenance, are now much higher than in the past.

And central to understanding this chapter of the American economic saga is the two-track economy, which has always existed, but is becoming ever-more acute after the pandemic and after the Fed started to raise interest rates.

“Wherever you look, it’s impossible to miss the two-track expansion,” note Puri and Farka. “A full 58% of U.S. households own stock, but the top 10% own 93% of equities; the top 1% own 38%. Households in the bottom 10% of the income distribution devote 75% of income toward necessities such as food, housing and transportation, compared to 55% for the top 10%. The bottom cohort also relies more on credit cards for spending: Households in the lowest decile of the income distribution have credit card debt equal to 85% of monthly income. By contrast, debt accounts for only 10% of income for households in the top decile.”

This two-track economy extends beyond the individual level. A small number of well-performing companies are powering the growth in the stock market, while the vast majority of firms languish.

The two-track economy explains the “vibes” economy. Topline numbers, such as wealth and consumption spending, are driven by the top cohorts, which are doing fine during this period, but sentiment is driven by the majority, which is not doing that well.

“Our baseline outlook of no recession reflects almost entirely the fortunes of the top cohorts,” the economists explain. “They still have heft and buffers to continue to spend. Their excess savings remain high, housing wealth and financial net worth has hit record levels, and income growth continues to remain strong.”

Though the economists do not expect a recession over the next year, they do believe that the U.S. economy will ultimately downshift, primarily due to the woes of the lower income households. Their debt levels are high, delinquency rates have risen and this cohort has begun to pull back on spending.

Major uncertainties include a tightening presidential election race that comes amidst the continuing culture wars and divisiveness of modern American politics and geopolitical tensions, including a war in the Middle East now in its second year.

The rise of AI is also a major factor in both the global and local economies. Right now, only 9% of U.S. companies integrate AI into their business operations.

In contrast, the Woods Center survey on Orange County businesses found a larger share of businesses that use AI: 34%.

That percentage is expected to grow exponentially in the coming years, much as the use of the internet exploded in the 1990s.

“The promise of generative AI – as a tool to transform companies, industries and societies – has taken the world by storm,” say Puri and Farka. “For all its hype, the AI wave has little to show so far, or so the thinking goes. It is essentially a vibe-driven revolution, at least for now. As for the impact of AI in the long term, it is perhaps best to be humble. There is much we don’t know, but we are optimistic that given time, the world will address thornier issues and AI challenges related to both supply constraints and potential demand limitations (a killer app or apps will ultimately appear). This will have crucial implications for productivity.”

Closer to home, Puri and Farka note that the Southern California economy, while not in recession, has downshifted much more than the national economy, with job growth slowing to a crawl over the past 15 months.

Home prices remain extremely high, exacerbating the homelessness crisis. Tens of billions of dollars for low-income housing and the $6.38 billion Proposition 1 homeless housing package promises new directions in handling this social and economic ill. But true progress remains elusive, at least at this time.

“There is no question that the past two years have been particularly volatile for the economy,” say Puri and Farka. “Fighting higher inflation while unwinding the post-pandemic stimulus could have resulted in a much slower economy, as most analysts predicted last year. But the strength of the U.S. consumer and the normalization of supply chains have so far kept GDP and employment growth in better shape than expected. Yet, as we get close to the end of the year, there are unmistakable signs of a slowing labor market and Southern California’s economies are experiencing that slowdown more severely than the national economy.”

To read the full economic forecast report, visit the Woods Center for Economic Analysis and Forecasting online. Or read more of our articles on past forecasts.