Podcast Summary
Economic recovery despite high unemployment: Despite high unemployment, household income increased in 2020 due to stock market growth, home price appreciation, and government stimulus. The future of consumer spending remains uncertain as the vaccine rollout and lockdowns continue.
The economic crisis caused by the COVID-19 pandemic has resulted in a unique situation unlike the 2008 financial crisis. While the stock market has seen unprecedented growth and home prices are booming, unemployment remains high. The quick reaction from the Federal Reserve and government stimulus packages have contributed to this unexpected recovery. Goldman Sachs Chief Economist Jan Hatzius was among the first to recognize this trend, predicting that household income would increase in 2020 despite high unemployment rates. The question going forward is how consumers will react to the events of 2020. Will there be a surge in spending once the vaccine is distributed and lockdowns are lifted, or will there be permanent damage to consumer confidence? As we enter 2021, this is a significant question that will shape the economic landscape.
A Different Economic Crisis from 2008: The COVID-19 crisis is unique with physical constraints driving the downturn and aggressive policy response leading to record declines and increases in GDP and income respectively.
The economic crisis caused by the COVID-19 pandemic is significantly different from the 2008 financial crisis. Jan Hatzius, an economist, highlighted that the market functioning issues in March 2020 brought back memories of 2008, but the economic backdrop was quite different. The downturn was driven by physical constraints on economic activity rather than financial factors. Moreover, the policy response was much more aggressive, leading to a record decline in GDP accompanied by a record increase in near disposable income. These factors indicate a very different economic cycle, and Hatzius has an out-of-consensus call for stronger economic growth in 2021 compared to the rest of the street. The health emergency and the subsequent policy response set this crisis apart from previous recessions.
The Significance of Fiscal Stimulus in the Economy's Recovery: Fiscal stimulus is crucial for income support during economic weakness, reducing job and income loss, and helping the economy rebound despite high virus cases and unemployment.
While people have savings and the economy is expected to rebound with the rollout of vaccines and the economy's full reopening, the short-term economic impact of fiscal stimulus is significant. Despite progress towards normalcy, high virus cases and unemployment call for additional support. Monetary and fiscal policies can help reduce the fallout in terms of jobs, incomes, and other sectors of the economy. Easier financial conditions are helpful but not enough to replace income directly, making fiscal policy necessary. The expiration of expanded unemployment insurance in late summer led to a temporary increase in spending by the unemployed but generally higher than expected levels. Overall, fiscal stimulus plays a crucial role in providing income support to those most affected by economic weakness.
Understanding Consumer Spending During the Pandemic: Fiscal policy and a unique sectoral balances framework have helped identify the role of income support in boosting consumer spending during the pandemic, with a potential for a private sector-led recovery as the economy normalizes.
The initial income support from unemployment benefits and tax rebates provided a cushion for consumers, boosting spending during the early stages of the pandemic. However, this boost is not expected to last forever, and some signs suggest that consumer spending may be running out of steam. The debate is ongoing about whether the unusual events of 2020 will lead to permanent spending cuts or a big rebound in consumer spending as the vaccine gets rolled out and lockdowns are lifted. As a leading real estate manager, I lean towards the latter, expecting people to return to spending on services and experiences similar to before. However, the sectors of the economy that are operating far below normal, such as travel and entertainment, may take longer to recover. Using a sectoral balances framework, which focuses on the private sector financial balance, allows for a unique perspective on the economy. This framework, influenced by economist Wynne Godley, emphasizes the importance of understanding the relationship between income and spending in the economy. In 2020, this framework has helped identify the role of fiscal policy in supporting the economy during the pandemic and the potential for a private sector-led recovery as the economy normalizes.
Private sector financial health and economic stability: During the spring lockdowns in 2020, the private sector ran a huge surplus, contributing to a rapid economic recovery. Current financial position suggests a lower vulnerability to asset price declines and their impact on borrowing and spending behavior.
The financial health of the private sector, including both households and businesses, is a significant indicator of the overall economic stability. Historically, large private sector deficits, often fueled by asset price bubbles, have left economies vulnerable to recessions when asset markets turn down. However, in contrast to the financial crises of the late 1990s, early 2000s, and 2008, the private sector ran a huge surplus during the spring lockdowns in 2020. This surplus, coupled with policy responses like substantial transfers to households, contributed to a rapid economic recovery. While financial imbalances and potential risks to the economy should always be monitored, the current private sector financial position suggests a lower vulnerability to asset price declines and their impact on borrowing and spending behavior.
The health of private sector balance sheets is crucial for assessing financial risks: Despite economic conditions and valuations, the private sector's financial health is a key indicator for financial risks. The 1999-2000 boom and the 2008 financial crisis underscored this importance.
While valuations and economic conditions are important factors in assessing financial risks, the health of the private sector's balance sheet may be an even more crucial indicator. This was highlighted during the 1999-2000 boom when the economy appeared strong, but the private sector was running a deficit, leading to a crash. The financial crisis of 2008 and the large government responses to the COVID-19 pandemic have shifted the focus towards private sector vulnerabilities. However, the debate on the importance of private sector financial balances as a metric is ongoing. Another topic discussed was the productivity puzzle, which refers to the surprisingly sluggish productivity growth over the past decade. The experience of 2020, with some sectors being effectively shut down, has shown strong productivity growth, but it's unclear yet if this is a trend or a composition effect due to the low productivity sectors being disproportionately affected.
Productivity gains in industries undergoing transformation during COVID-19: The pandemic may bring temporary or permanent productivity improvements in industries undergoing significant changes, but accurately measuring productivity in a service-based economy is challenging. Demand-side policies can stimulate the economy, but their impact on productivity is uncertain.
The COVID-19 pandemic may have led to unexpected productivity gains, particularly in industries undergoing significant transformations like retail shifting from brick-and-mortar to online sales. However, it's unclear whether these gains are temporary or permanent. Another important issue is the challenge of accurately measuring productivity as the economy moves away from producing tangible goods towards services and virtual goods. Demand-side policies, such as direct stimulus to boost aggregate demand, have proven effective in addressing economic downturns, but their impact on productivity is less clear. Cyclical effects on productivity through labor utilization and employment shakeout may also play a role.
Productivity and economic growth: Not always linked: Productivity measures should be adjusted for utilization, and economic growth doesn't always lead to higher productivity or faster growth. Demand side policies are effective in stabilizing the economy, but their impact on productivity is secondary. Inflation remains low in the US, and a reversal would require significant policy or economic changes.
Productivity measures should be adjusted for utilization, and the cyclical effects on productivity are not enormous, meaning that a stronger economy does not always lead to higher productivity or faster productivity growth. Demand side policies are effective in stabilizing the economy during slumps, but their justification does not primarily rest on the productivity story. The successful rollout of vaccines and resulting economic growth may lead to upward pressure on wages and price inflation, but it will take significant strength in real activity and pressure on labor markets to achieve substantial increases. Despite the disinflation trend over the last 40 years, inflation remains low in the US, with core PCE inflation averaging around 1.5% to 2%. The low inflation environment since the mid-1990s can be attributed to various factors, including globalization, technological advancements, and monetary policy. A sustained reversal of this trend would require significant shifts in policy or economic conditions.
The Fed's shifting approach to inflation targeting: The Fed has shifted from a strict 2% inflation ceiling to an average 2% rate, aiming for more accommodative monetary policy and fewer rate hikes.
The Federal Reserve's approach to inflation targeting has shifted significantly over the past few decades. In the late 1970s and 1980s, the Fed focused on bringing down inflation and stabilizing expectations at around 2%, even if it meant averaging slightly below that level. However, in recent years, concerns have grown that this target may be too low, leaving insufficient room for rate cuts during economic downturns. As a result, the Fed has adopted a new framework that aims for an average inflation rate of 2%, rather than a strict 2% ceiling. This change could lead to more accommodative monetary policy and fewer interest rate hikes in response to inflation. Another major surprise of 2020 was the devastating impact of the COVID-19 pandemic on the economy. While previous scares had failed to cause significant economic damage, the pandemic proved to be a game-changer. Despite initial concerns, the economy quickly adapted to new ways of working and shopping, with retail sales returning to pre-crisis levels and productivity remaining relatively stable. However, the pandemic's effects on individual lives and businesses have been profound and far-reaching. Overall, the Fed's new inflation targeting framework represents a significant departure from past practice, with potential implications for monetary policy and economic stability. Meanwhile, the COVID-19 pandemic continues to pose unprecedented challenges for the economy and society as a whole.
Understanding the Role of Monetary Policy in a Full Employment Economy: Economist Jan Hatzius advocates for an eclectic approach to understanding the economy and determining policy responses, emphasizing the importance of sectoral balances and the need for a nuanced understanding of monetary policy in a full employment economy.
While the shift in monetary policy may lead to significant short-term impacts, particularly during individual economic cycles, the long-term implications are not expected to be massive. Jan Hatzius, an economist known for his work on sectoral balances and his sympathies towards Modern Monetary Theory (MMT), sees the usefulness of an eclectic approach to understanding the economy and determining policy responses. In a slump, aggressive stimulus from both monetary and fiscal sides is often the right policy response. However, in a strong economy with full employment and central bank inflation targets, the policy prescriptions change significantly. Although a government technically cannot go bankrupt with a central bank buying its debt, the right policy responses in a full employment economy differ from MMT prescriptions. Hatzius also emphasized the importance of the sectoral balances approach, which he finds useful, but without labeling it specifically. The current economic crisis is unusual and government-induced, leading to an enormous effect from monetary and fiscal interventions, compressing the recession into a shorter cycle than what was seen in 2008.
Impact of COVID-19 on Economy and Household Balance Sheets: Despite the economic turmoil caused by the pandemic, household balance sheets could offer stability in the coming years due to increased saving. Previous periods of economic optimism led to crises due to large private sector deficits, but household balance sheets were strong going into the current crisis.
The economic impact of the COVID-19 pandemic and subsequent lockdowns cannot be underestimated, but it's important to note that household balance sheets may provide a cushion of stability in the coming years. During periods of peak optimism, such as in 1999 and 2005, the private sector ran large deficits, leading to economic crises. However, going into the current crisis, household balance sheets were in good shape and have improved further due to increased saving. The unexpected nature of the economic developments in 2020 highlights the limitations of economic modeling. The annual end-of-year conversation between Jan Hatzius and the hosts of All Thoughts Podcast is a promising idea to discuss the economic developments and their implications in more detail. Matt Levine and Katie Greifeld's new podcast, Money Stuff, is another exciting addition to the Bloomberg Podcast network, where they will discuss Wall Street finance and other related topics every Friday.
