U.S. Economy: Solid recovery, but output gaps will remain

The Covid-19 pandemic and measures to contain it have led to a dramatic slump in economic performance in the United States. After the U.S. economy shrank by 5.0 and 31.4 percent (annualized, the quarterly rates were -1.3 and -9.0 percent) in the first two quarters of the current year, the recovery in economic performance was strong during the summer. Gross domestic product increased at a rate of 33.1 percent (again annualized, the quarterly rate was 7.4 percent). Thus, the U.S. economy is likely to have grown fast in the second half of the year. The availability of vaccines against COVID-19 will probably support the recovery next year. For the whole year of 2020, I expect a decrease in GDP of around 3.5 percent and a positive growth rate exceeding 3 percent in 2021.

The Covid-19 pandemic and measures to contain it have led to a dramatic slump in economic performance in the United States. Following the dramatic slump in economic output in the first half of the year, there was a strong recovery in the summer months after the pandemic had been contained somewhat for the time being and the various lockdown measures had been partially lifted. The main stimulus to the economy in the summer was the financial aid package adopted in March. Key elements of the program were an increase in unemployment benefits until the end of July and one-off payments to low and middle-income households. A significant number of the unemployed are thus likely to have temporarily earned more than they previously did with a job. Above all, private consumption was thus supported. In addition, the savings rate of households has risen, allowing many people to build up a financial cushion for the following months.

Fast recovery in the third quarter

As a result of these developments, gross domestic product grew strongly by 7.4 percent in the third quarter according to the Bureau of Economic Analysis (BEA). Similar to the previous slump in the second quarter (a drop of 9.0 percent), this growth is also the strongest since quarterly GDP data have been published. However, economic output in the third quarter was still 3.5 percent down on the level seen in the final quarter of 2019. Both private consumption and corporate investment have once again shot up. Private consumption grew very strongly by 8.9 percent in the third quarter, following a slump of 11.2 percent in the first half of 2020. Not all consumption categories have been equally affected by the Corona crisis. Given that the various lockdown measures have restricted or rendered the provision of personal services impossible, real consumer spending on services as a whole slumped by 14.9 percent in the first half of the crisis and, against the backdrop of a further increase in the number of corona cases and restrictions, grew at 8.3 percent in the third quarter, less strongly than purchases of consumer durables, which even grew by 16.3 percent over the summer following a slight slump of 3.7 percent in the first half of the year. The crisis has so far also had less of an impact on non-durable consumer goods, which include food and other goods for daily use, than on services.

This pattern shows that the corona crisis differs markedly from other recessions, in which the purchase of durable consumer goods such as cars, furniture or computers is postponed, while personal services usually suffer less. The pattern to date also indicates that economic development in the coming months is likely to be severely dampened by the continuing high number of corona cases, since under these circumstances it is unlikely that the service sector will experience a strong recovery. The purchase of consumer durables to date may also be due to the fact that many households have temporarily made purchases for work from home, leisure activities or means of transportation, such as cars or bicycles, in the course of increasing work from home and avoiding large crowds of people. This may not be repeated to the same extent in the future.

Foreign trade also shows a pattern in which trade in services – which among others includes tourism and professional travel – has been affected much more than trade in goods. The United States’ trade deficit has risen significantly in this year of the Corona. By preventing an even sharper slump in private consumption, the financial stimulus measures also had a supporting effect on imports from the rest of the world.

Rather unexpectedly, corporate investment also showed a remarkably clear brighter picture in the third quarter, although there were various negative factors such as uncertainties about the further course of the pandemic and economic development, as well as the uncertain outcome of the US presidential and congressional elections. After a decline of 9.2 percent in the first half of the year, the third quarter saw an increase of 5.1 percent. As expected, investments in equipment were volatile this year, while spending on research and development or software, which is also otherwise less sensitive to economic cycles, reacted much less strongly and less quickly to the slump and recovery of the economy.

Unemployment rate steadily decreases

In the spring, there were dramatic effects on the job market. The official unemployment rate was at 14.7 percent in April, but the “true” unemployment rate was probably at least 5 percentage points higher due to measurement issues. Since April, the unemployment rate has decreased to 6.7 percent in November. However, the pace of the recovery has gradually slowed down. The improvement on labor markets was rather modest in November. It will probably continue to gradually decline, but unemployment will remain higher than before the Covid-19 pandemic for a considerable period of time. This will also dampen the evolution of wages. While disposable personal income was until July strongly supported by fiscal stimulus measures such as the temporary higher unemployment benefits, it has decreased in the period from August to October. Currently, I expect a subdued evolution of personal income in the coming months, which will also dampen private consumption and the economic recovery. If no further fiscal stimulus measures are adopted, many unemployed might no longer receive unemployment benefits in 2021. Since May, job growth occurred in most sectors of the economy and was particularly strong in sectors such as hospitality, leisure, food services and drinking, retail trade or health services, which were all hardly hit by the pandemic and the lockdown. Let me stress that employment levels in most of these sectors remains well below their pre-pandemic levels.

Further fiscal stimulus measures?

The U.S. government’s extensive fiscal measures have been supportive in the first half of the year. These measures included direct transfers to low- and middle-income households, an increase and prolongation of unemployment benefits, and emergency loans for businesses. However, since August, unemployment benefits have been lower. The political parties have not yet agreed on new fiscal stimulus measures. In the baseline version, I do not assume that further stimulus measures will be adopted. But I provide some scenario analysis here where I assume that a fiscal stimulus program will be adopted and implemented in 2021.

Monetary policy also strongly supports the economy. The U.S. Federal Reserve cut its key interest rates to almost zero percent in two steps. Extensive asset purchase programs were also adopted and various measures were taken to ensure liquidity in the financial system. On August 27, the Fed communicated that it will start to target an average inflation rate of two percent (average is new), which might result in a somewhat higher inflation rate in the future. This would mean that a year-long undershoot of the inflation target – as was the case in previous years, would in the future be compensated for by a temporary overshoot. As a result, monetary policy might remain a bit more expansionary in the next year than under the previous monetary policy strategy. With the gradual recovery of the U.S. economy, the situation on the labor market will improve; the unemployment rate will probably drop below 6 percent in the first half of 2020. However, the situation on the labor market will remain concerning.

All in all, the U.S. economy is likely to contract at a rate of around 3.5 percent in 2020. The decline in growth from the first half of this year will probably not be offset until early 2022. My growth forecast for 2021 is currently at 3.5 percent. For 2022, I expect a growth rate of 2.3 percent. Obviously, such forecasts are associated with a very high degree of uncertainty.

While I use several models in my forecasts, my published numbers are also strongly influenced by my personal experience and judgment.

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