The January inflation bump Americans should welcome

Inflation was the bogeyman of 2022. Here at the dawn of 2023, the big question for the U.S. economy is whether or not — and when — we’ll dip into a recession this year. In that respect, the bogeyman could become more of a friend.

Look for inflation to provide an underappreciated boost to the economy this month, and that should push out recession risk until later in the year, at the very least. Social Security, Internal Revenue Service tax brackets, pay scales for government workers and minimum wages in some states adjust for inflation this month, just as they do every January. But because 2022 was the highest year for inflation in 40 years, the one-time adjustments that happen this month will pack a bigger punch than they have in decades.

Adding them all together will boost household incomes by around $200 billion, or 1% of disposable personal income. Measured against a Federal Reserve determined to slow the economy to rein in inflation, that isn’t enough to prevent a recession in 2023, but it should mean the risk of recession in the first quarter, and likely the second, is very low.

The Social Security adjustment is probably the most familiar to Americans — recipients will get an 8.7% boost in their payments starting this month. With more than 50 million people receiving Social Security payments, this means monthly payments will increase by $7.3 billion this month, or almost $90 billion annualized. If inflation had been closer to the Fed’s 2% target we would be looking at more like a $20 billion annualized increase, so this is a sizable difference.

The next category might not be as well understood: Tax brackets adjust every year for inflation, as well. For instance, in 2022 the jump to 22% from 12% in the federal tax rate happened when taxable income exceeded $41,775. In 2023 that jump will happen at $44,725. So if you have at least $45,000 in taxable income, congratulations, you’re getting a $300 tax cut.

This one bracket shift works out to tens of billions of dollars when you’re talking about tens of millions of taxpayers with more than $45,000 in taxable income. There also is another meaningful shift for higher earners — moving to the 32% bracket from 24% will happen at more than $182,100 in taxable income in 2023, rather than $170,050 in 2022, which works out to about a $1,000 tax cut for those filers.Moving on are a couple smaller line items: pay for federal government employees and state minimum-wage levels. Because of the high level of inflation, federal government employees will get a 4.6% pay increase this year, up from a 2.7% increase in 2022. That will boost the income received by federal government employees by $12 billion. And then 13 states, including New York and New Jersey, index their minimum wage to inflation, which will boost worker incomes across America by a harder-to-measure total amount.

The obvious retort against the impact of all these adjustments is that it’s merely making people whole after absorbing so much inflation last year, but it isn’t that straightforward. There has been a lag between when inflation hit and when incomes are adjusting for it. Imagine paying $1,500 out of pocket for a work trip in June and finally getting reimbursed in January. Sure, you’re just getting back what you’re owed, but you might have had to curtail consumption or dig into savings until you got paid back, and then once you finally get reimbursed it can feel like a bit of a windfall.

That’s what more than 100 million Americans will go through this month. So given the annual boost to income plus the impact of falling gasoline prices and downward pressure on core goods prices, January is likely to be one of the strongest months for real income increases on record. Some percentage of it might be saved, bolstering savings-rate levels that have fallen very low in recent months, but some percentage is going to get spent, boosting consumption and supporting overall economic growth.

This might not be the most welcome development for the Federal Reserve, which has been trying to slow the economy. As the January adjustments flow into the data received later in the quarter, it could lead the Fed to a more hawkish outlook this year than anticipated — though that will depend on the course of inflation data, as well.

The bottom line is if you’re bracing for a recession to start early this year, you should push out that forecast — recessions don’t happen when inflation-adjusted incomes for households are rising. The impact of the federal government compensating Americans for some of the inflation they absorbed last year should mean economic growth will be fine for a while longer.