Post from First Trust Economics Blog

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

Sept 7th, 2021

In early 2020, when COVID hit, the unemployment rate in

the United States was 3.5%, wages for low-income earners were

rising faster than wages for high-income earners, living standards

were rising…the economy was on a roll.

Then, because scientists said lockdowns would stop

COVID, they turned the light switch off. Real GDP fell at a 5.1%

annual rate in the first quarter of 2020 and then an annualized

31.2% in the second quarter.

Since then, because of re-opening, Federal Reserve money

printing, and massive Treasury debt issuance to fund pandemic

loans and benefits, the economy has rebounded. Real GDP hit at

an all-time high in Q2 this year, 0.8% higher than it was at the

pre-COVID peak at the end of 2019.

But this is not very comforting. Not only would the

economy have grown roughly 3% in the absence of COVID, the

economy has been boosted by over $800 billion in direct

payments to individuals. That $800 billion is roughly 4% of

annual GDP. Without this borrowing from the future, the

economy would be smaller today, not larger.

We estimate that the lockdowns have cost the US economy

6% (4% from stimulus growth + 3% growth absent COVID –

0.8% all time high from pre-COVID peak) in lost output. Of

course, it doesn’t appear this way because borrowing from the

future allowed more spending today. It’s like giving morphine

to an automobile crash victim. No pain, but underlying injuries.

So, how long will it take to fully recover? Factors that will

boost growth include the general waning trend in COVID (yes,

in spite of Delta, the death rate is running well below levels last

winter), the natural process of economic recovery, faster

productivity growth, entrepreneurs – who have packed many

years of innovation into the past eighteen months – and the loose

stance of monetary policy.

It’s important to pause for a moment and recognize that

monetary policy, with short-term interest rates set near zero, has

effectively become looser as inflation has moved upward. In the

past year, the consumer price index is up 5.3%, which means that

a short-term interest rate target of 0.1% generates a “real”

(inflation-adjusted) interest rate of -5.2%. By contrast, the

lowest real short-term interest rate in 2020 was -1.4% in March

2020. To put this in perspective, the lowest real rate in the

aftermath of the Financial Crisis was -3.8%.

However, at least a few factors will also weigh on economic

growth in the year ahead. First, the removal of fiscal stimulus

compared to what was done in 2020 and early 2021. Take away

the pain medication and the economic pain will become even

more evident.

This underlying damage is reflected in the many small

businesses that have been destroyed by COVID lockdowns that

will not be there to help the economy rebound like they would

have after prior recessions. This problem is made worse by

excess unemployment benefits. Not only do these benefits slow

the recovery, but they translate into an erosion of worker skills

and know-how.

We think we’re seeing these negatives at work in some

recent tepid economic reports. Nonfarm payrolls grew only

235,000 in August, far below consensus expectations. Yes, there

is evidence that the Delta variant (and related policy responses)

were responsible for a significant portion of the slowdown in job

creation. Restaurants & bars reduced payrolls by 42,000 in

August versus a gain of 290,000 in July. But Delta wasn’t the

only factor. Just look at auto sales. Cars and light trucks were

sold at a 13.1 million annual rate in August, the slowest pace in

fifteen months and far below consensus expectations.

As recently as August 17, the Atlanta Fed’s GDP Now

model was tracking 6.2% annualized real GDP growth in the

third quarter. Now, three weeks later, it’s tracking 3.7%.

The next several weeks are important. It looks very likely

that the bipartisan infrastructure bill, boosting spending by about

$550 billion over the next decade, will pass. What’s unclear is

whether President Biden and his legislative allies can pass a

partisan bill of up to $3.5 trillion in extra spending, along with

tax hikes. The odds still favor the Democrats getting something

through on partisan lines, but the odds of a total failure to pass

the partisan bill are growing, and recent comments by Senator

Joe Manchin (D-WV) suggest that if something passes it will be

substantially less than what the far left wants.

In the end, a “full recovery” of the economy is possible, but

damage from past or future shutdowns – and a large partisan bill

that once again, like New Deal or Great Society legislation,

significantly increases the influence of the government over the

economy – threaten its pace.