U.S. Economy: Fiscal relief and stimulus supports the recovery

In 2020, 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 2020, gross domestic product increased at a rate of 33.4 and 4 percent (again annualized, the quarterly rates were 7.5 and 1 percent). Overall, the U.S. economy contracted at a rate of 3.5 percent in 2020. The availability of vaccines against COVID-19 will support the recovery in 2021. In addition, fiscal relief and stimulus measures adopted in December 2020 will significantly support the economy in 2021. For 2021, I currently expect an increase in GDP of 5.5 to 6 percent. For 2022, economic growth will slow down to 3 to 3.5 percent. If further fiscal relief and stimulus programs are adopted this spring, one may expect considerably higher economic growth rates.

In the United States, the economy grew at an annualized rate of 4.0 percent in the fourth quarter. In the third quarter, gross domestic product had shot up by 33.4 percent, having slumped by 31.4 percent in the second quarter due to various measures to contain the pandemic. Business investment grew at solid rates in the fourth quarter; private consumption expanded at a rather modest rate. Housing construction expanded strongly in view of low interest rates. Imports have increased more than exports, which widened the trade deficit.

After the Covid-19 pandemic and the measures taken to contain it had led to a dramatic decline in economic output in the first half of the year, the continuing difficult pandemic situation had a much less significant impact on economic activity in the fall and winter. Companies and households were better able to adapt to the new situation. Nevertheless, the economic situation is extremely difficult for many companies and households. Even though more and more people are now getting vaccinated against the coronavirus – more and more vaccines are now being approved – the pandemic situation remains difficult. Various containment measures and uncertainties about the further course of the pandemic remain, dampening economic momentum. New mutations could reduce the efficacy of vaccines or therapies, or lead to further lockdown measures due to increased transmissibility.

Services consumption affected the most

Not all consumption categories were equally affected by the Corona crisis in 2020. As the various lockdown measures restricted or made impossible personal services, real consumer spending on services as a whole slumped by 14.9 percent in the first half of 2020 and, against the backdrop of high Corona case numbers and various restrictions, only rose by 9.5 percent in the second half of the year. The pattern looks differently for purchases of durable consumer goods (for example, cars, furniture or computers). After a small slump of 3.7 percent in the first half of the year, these actually increased by 16.2 percent in the second half. It is possible that many households, in the wake of increased home working and the avoidance of larger crowds, have made temporary purchases against the backdrop of much more work from home, leisure activities or means of transport such as cars or bicycles, which are unlikely to be repeated on this scale. For similar reasons, residential investment, which is also being stimulated by low interest rates, has probably increased significantly recently.

The crisis has also so far left less of a mark on nondurable consumer goods, which include such items as food and other everyday goods, than on services. This pattern shows that the Corona crisis has marked differences from other recessions, in which purchases of consumer durables in particular are postponed, while personal services typically slump less. With Corona case numbers remaining high, these services are not expected to recover quickly, which is likely to dampen further economic development.

Higher trade deficits

Foreign trade also shows a pattern in which services are more affected by the Corona pandemic than goods. Trade in services – which includes tourist and professional travel – was hit much harder than trade in goods. For example, goods imports contracted by 18.3 percent in the first half of the year and increased at a rate of 28.8 percent in the second half. Imports of services, on the other hand, initially slumped by 31.9 percent and have recently increased by only 11.2 percent.  Exports show a similar pattern – it is worth noting that they have fallen much more sharply than imports in the current year. As a result, the trade deficit of the United States has risen significantly so far since the beginning of 2020. The fiscal stimulus measures adopted in March prevented an even sharper slump in private consumption and thus also had a supporting effect on imports.

A remarkably clear upturn was seen in business investment in the third quarter, despite various adverse factors such as uncertainties regarding the further course of the pandemic, economic developments and the uncertain outcome of the US presidential and congressional elections. Following a decline of 9.2 percent in the first half of the year, there was an increase of 8.7 percent in the second half. Investment in equipment was volatile, while spending on intangible investments such as research and development or software, which are also otherwise less sensitive to the economic cycle, reacted much less strongly to the slump and the subsequent recovery of the economy.

The economic recovery and private consumption are dampened by high unemployment. By contrast, private consumption is being supported by the relief and stimulus package adopted at the end of December, which includes an extension and increase in unemployment benefits until the end of March. In addition, cash payments were decided in the amount of $600 for individuals with small or medium incomes as well.

Only gradual reduction in unemployment

Nevertheless, the unemployment rate is expected to remain elevated. It shot up from 3.5 percent in February to 14.7 percent in April. Due to classification problems, however, the actual unemployment rate in the spring and summer may have been significantly higher in some cases. By January 2021, it had gradually fallen to 6.3 percent in December. However, the extent of the problems on the labor market is greater than this figure would suggest. For example, many people have withdrawn from the labor market, at least temporarily. The labor force participation rate has declined since the outbreak of the pandemic. Unemployment is expected to decline only slightly, if at all, until spring. Pandemic-related restrictions on economic activity, particularly in personal services, are not expected to ease gradually until later in the spring. As the US economy gradually recovers, unemployment will gradually decline in the course of this year. Business investment should also continue to increase gradually. The trade conflict between the United States and China is likely to continue. At the moment, it is difficult to gauge the course of the new US administration; an easing of tensions or a comprehensive agreement should not be expected at present.

The U.S. economy is supported by a very expansive monetary policy. The key interest rate has been at almost zero percent since March. In addition, extensive securities purchases are being carried out. Monetary policy is likely to remain expansionary in the forecast period – also because the central bank is now likely to allow slightly higher inflation on average than in previous years. The U.S. Federal Reserve announced a revised monetary policy strategy on August 27, according to which it is now targeting average inflation. This means that in the future it could allow a longer moderate overshooting of the inflation rate above this average inflation target to compensate for a previous undershooting. As before, the inflation target for the personal consumption expenditures index is two percent.

Further relief and stimulus measures?

Further support for the recovery of the U.S. economy would come from the relief and stimulus package currently under discussion, worth up to $1.9 trillion, proposed by the new President Joe Biden. What the package would look like is still unclear given the ongoing discussions in Congress. Almost certainly, unemployment benefits would be further extended, additional one-time payments would be made to low-income households, and support measures for states and cities would be added. Such a package would support people and help the U.S. economy to make up for the growth losses caused by the corona pandemic. It may be one of the boldest fiscal stimulus measures in the history of the United States. One may expect that GDP growth would be at least 2 percentage points higher in 2021 than under my baseline scenario. According to my estimates, it is more likely that economic growth would be 3 to 4 percentage points higher. Thus, it might be that the economy would enter a considerable boom period this year if further fiscal aid and stimulus is adopted. It does not have to be bad: many employees would see wage increases or unemployment people would find jobs. In general, one should see it as positive. However, one should bear in mind that undesirable side effects of such a stimulus might emerge such as higher inflation or a boom in real estate or asset prices. Monetary policy would surely have to reduce its quantitative easing programs faster and increase interest rates faster than currently planned. It would be important that the Fed reacts in a timely manner if the economy would indeed enter a boom period.

All in all, I expect the U.S. economy to grow at a rate of about 5.5 percent this year. In 2022, the economy may be expected to grow by 3.0 to 3.5 percent.

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