Policy and fiscal risks could hamper long-term economic recovery

The institution for 2021 seems clear: a powerful growth path fueled by a spike in government spending as the US recovers from the Covid-19 crisis and in the fastest economic acceleration in nearly 40 years.

But what then?

The path to this rocket-powered year seems much less clear.

One-off spending has rarely been the catalyst for long-term growth. Fiscal and monetary policies that now serve as irresistible headwinds may soon turn into headwinds. On the other side of this huge activity will be an economy that holds inequality and two-speed recovery, which is likely to require more than the occasional payment by the government.

So while growth in gross domestic product may reach 7% or more in 2021, do not get used to it. An economic settlement is probably ahead.

“I do not see growth being particularly sustainable,” said Joseph LaVorgna, chief economist for Natixis’ Americas. “The economy is going to slow down a lot more next year than people think and is likely to be below 3%.”

LaVorgna, the chief economist of former President Donald Trump’s National Economic Council, sees a number of obstacles, many of which are related to policy.

In the immediate climate, trillions of direct payments have helped increase consumer spending and imports. The trend so far is for robust credit and debit card spending to cool as soon as the initial shock of the stimulus subsides.

At the door are higher tax rates for companies and wealthier Americans. The Biden administration’s intense focus on tackling climate issues is also likely to increase the regulatory burden that small businesses in particular have.

“How the 2022 development with respect to Congress will be a major obstacle to long-term business planning and decision-making, at least to the extent that you will not get a solid set of capital spending plans,” LaVorgna said.

‘At this point I do not see [businesses] a big long-term commitment to factory building or anything that will have a long shelf life, because you are not sure what the regulatory and tax environment looks like there. ‘

Then there is the issue of those who are on the lower rungs of economic learning.

While the transfer payments are helping in the short term, employment is still showing a slow recovery for lower earners, with stubbornly high weekly demands for unemployment and a gap of 3 million hospitable jobs that is far from coming back. According to the Federal Reserve, the unemployment rate for the bottom quintile in the 20% range is still high.

“Everyone expects a key-saving economy: we just have to reopen and move on, and things will go perfectly,” said Nela Richardson, chief economist at ADP, which pays a monthly number of privately paid people. “I do not think you will get key. There are significant scars in the labor market. Some consumers have done damage.”

Richardson is in the camp of those who have a K-shaped recovery, where those in the higher sports lengths retain or even thrive during the pandemic, while those at the bottom have lost ground.

The chairman of the Fed, Jerome Powell, said in an interview broadcast on Sunday on the ’60 minutes’ of CBS that the central bank was focused on the issues faced by employees in the service industry, and promised to keep policy focus in that direction.

“It’s going to take a while. The good news is that we’re starting to make progress now. The numbers show that people are now returning to restaurants,” Powell said. “But I think we have to keep in mind, we are not going to forget the people who were really left without jobs on the beach as this expansion continues. We will continue to support the economy until the recovery is really complete.”

This policy support was critical to getting the economy back on track and for the financial markets to function.

Fed officials believe they can continue to push the accelerator to the floor without risking a burdensome rise in inflation, even as consumer prices rose by 2.6% in March from the previous year and 0.6% from last month.

Powell and his co-policymakers view recent inflation trends as temporary and the result of supply chain issues that will disappear, along with easy comparisons to a year ago when inflation disappeared as the pandemic.

But the Fed, and especially the Powell Fed, have gotten into trouble before when trying to predict long series.

At the end of 2018, the central bank had to return to plans to continue raising tariffs when trade war issues hit the world economy. A little over a year later, the Fed’s promise to stop the rate cut disappeared when the pandemic struck.

Although defenders of the Fed would say that these were unforeseen events, this is the point: making long-term promises is a Sisyphean task in a world economy where the sand shifts so frequently.

“The biggest risk for expansion is the Fed,” said Steve Blitz, a U.S. economist at TS Lombard. “The puppet master is trying to control a puppet they have no control over.”

Still, Blitz thinks the Fed’s policy last year, in which it promised not to step up before seeing real inflation rather than just forecasts, ‘is the right thing to do, because their forecasts stink.’

Both the monetary policy of the Fed and the fiscal policy of Congress are likely to remain loose until the underlying issues of the economy are addressed, he added.

“Everyone realizes that the political cost of ignoring the drug now is too high,” Blitz said. “Both parties are sitting on the knife edge. Who can do the best through fiscal spending … to win back the middle vote?”

Consumers have so far used some of the stimulus they received from Congress to buy and invest, but are still cautious.

According to data from the New York Fed, the three rounds of checks are gradually being spent less and saved more. The numbers tell a twin message: that consumers are building up their balance sheets, which indicates great spending power going forward, but is also increasingly reluctant to share some of the cash.

What economists call the marginal propensity to consume dropped in the first round of stimulus tests in the spring of 2020 to 29% in the latest distribution.

“As the economy reopens and fears and insecurities subside, the high levels of savings should facilitate more spending in the future,” New York Fed economists said in a recent report. “However, there is a great deal of uncertainty and discussion about the pace of this increase in spending and the extent of the pent-up demand.”

Indeed, the future of the economy after the outbreak of 2021 will largely depend on the story of how many people really can not wait to spend after being tracked down for a year, and how long it will last.

Mark Zandi, chief economist at Moody’s Analytics, is more optimistic about the fate of the economy. He is looking forward to another outburst of activity due to the looming infrastructure bill, with spending likely to take root only in 2023 and beyond.

“It will launch a self-sustaining economic expansion. There is so much juice here that we will be back in full service within the next 18 to 24 months,” Zandi said. “Once this juice decreases in the short term, we’ll get another chance.”

However, the economy will endure a lot in that period.

As always, there is the pandemic. Although almost all the news with vaccines was good, a sudden increase in variants could lead some tormented officials to re-lock sections of the economy.

And there is the inflation question.

If the Fed is right, it can loosen policy and sustain growth. If it goes wrong, Powell conceded that the primary instrument will be interest rate hikes that, while unlikely to work out the recovery, could delay it significantly. Housing, which led the economy out of the recovery, would suffer the biggest blow.

Fernando Martin, economist of the St. Louis Fed, said a combination of rising inflation expectations, falling unemployment and the increase in money supply for the economy could apply inflation longer than policymakers are currently proposing.

“If this pressure materializes and proves to be persistent, the Fed will eventually have to step in to lower inflation and reach its target of 2% average inflation,” Martin wrote, although he also said that inflation could possibly remain low.

There will probably also be a fiscal settlement.

Halfway through the financial year, the government already has a budget deficit of $ 1.7 trillion, as total national debt recently reached the $ 28 trillion level. The public debt is about $ 22 billion, or 102% of GDP.

The congress that goes to the midterm elections next year may want to look more fiscally responsible, thus boosting the free – wheeled spending that will spur the economy this year to its strongest annual performance since 1984.

Zandi sees a policy shift as the biggest danger to the long-term economic view.

“For the economy not to expand self-sustainably, it is a policy mistake,” he said. “We will have to do something wrong. Either the Fed brakes too hard or fiscal policymakers no longer succeed in their support.”

The support is essential because the country is trying to avoid a recovery that leaves too much behind, Zandi added.

“The risks are significant. It goes to a K-shaped recovery, income and wealth inequality, racial inequality issues, climate change,” he said. “These are profound issues that I do not think can be addressed without a very comprehensive policy response.”