Political and fiscal risk could hinder long-term economic recovery

The scenario for 2021 seems clear: a powerful growth trajectory driven by government spending inflows as the US recovers from the Covid-19 crisis to the fastest economic acceleration in nearly 40 years .

But then what?

The path beyond this rocket-driven year seems much less clear.

One-off spending has rarely been the catalyst for long-term growth. The fiscal and monetary policy that now serves as irresistible tailwinds could soon turn into headwinds. On the other side of this huge burst of activity will be an economy plagued by inequality and a two-speed recovery that will likely take longer than the occasional government transfer payment.

So while the gross domestic product growth in 2021 could reach 7% or more, don’t get used to it. An economic calculation is likely to be made.

“I don’t see the growth as particularly lasting,” said Joseph LaVorgna, chief economist at the Natixis Americas. “The economy will slow down much more next year than expected and is likely to be well below 3%.”

LaVorgna, chief economist at former President Donald Trump’s National Economic Council, sees a number of hurdles, many of them related to politics.

In the immediate climate, billions of direct payments have helped drive consumer spending and imports. But so far, the trend has been for solid spending on credit and debit cards to cool once the initial shake-up of the stimulus proves to be declining.

Higher tax rates are expected for businesses and wealthier Americans. In addition, the Biden administration’s intense focus on addressing climate issues is likely to add to the regulatory burden that is particularly harsh on smaller businesses.

“The development of 2022 relative to Congress will be a major factor in long-term business planning and decision-making, at least to the extent that you won’t get a robust set of capital spending plans.” LaVorgna said.

“Right now, I don’t see it [businesses] making a big long-term commitment to building factories or anything that has a long service life, because you’re not sure what the regulatory and fiscal environment looks like. ”

Then there is the issue of those at the bottom rungs of the economic ladder.

Although transfer payments help in the short term, employment data continues to indicate a slow recovery for lower-income people, with selflessly high weekly job demands and a remaining gap of 3 million jobs. ‘hospitality that seem far from back. Federal Reserve estimates continue to keep the lower quintile unemployment rate in the 20% range.

“Everyone expects a turnkey economy: we just have to reopen and move on and things will go perfectly,” said Nela Richardson, chief economist at payroll processing company ADP, which distributes a widely followed monthly count. of private payroll occupations. “I don’t think you get turnkey. There have been major scars in the job market. There has been harm to some consumers.”

Richardson is in the field of those who see a K-shaped recovery, where those at the top have maintained or even prospered during the pandemic, while those at the bottom have lost ground.

Fed Chairman Jerome Powell said in an interview aired Sunday on CBS’s “60 Minutes” that the central bank is attuned to the problems facing service industry workers and pledged to maintain the policy approach in this direction.

“It’s going to take a while. The good news is that we’re starting to move forward now. The numbers show people are coming back to restaurants now,” Powell said. “But I think we have to keep that in mind. We won’t forget those people who were left on the beach really out of jobs as this expansion continues. We will continue to support the economy until the recovery is really complete.”

This support for politics has been fundamental both to the revival of the economy and to the functioning of financial markets.

Fed officials believe they can continue to push the accelerator to the ground without risking an inflation problem, although consumer prices rose 2.6% in March last year and 0.6% % of the previous month.

Powell and his political colleagues see recent inflation trends as temporary and the result of supply chain problems that will dissipate, along with easy comparisons from a year ago, when inflation disappeared when the pandemic hit. hit.

But the Fed, and in particular the Fed Powell, has run into problems before trying to predict the long term.

In late 2018, the central bank had to back down from plans to continue raising rates when problems related to the trade war affected the global economy. Just over a year later, the Fed’s commitment to stop cutting rates disappeared when the pandemic hit.

While Fed advocates might say they were unforeseen events, here’s the point: making long-term policy commitments is a sissy task in a global economy where the sands move so often.

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

Still, Blitz believes the Fed’s policy pushed last year, in which it pledged not to tighten until it sees real inflation that only forecasts “are right, because their forecasts make modesty “.

Both the Fed’s monetary policy and Congress ’fiscal policy in general will remain weak until the underlying problems of the economy are addressed, he added.

“Everyone recognizes that the political costs of ignoring the center are now too high,” Blitz said. “Both sides are sitting on the edge of the knife. Who can do the best thanks to tax spending … in recovering that average vote?”

To date, consumers use some of the incentives they have received from Congress to buy and invest, but continue to be cautious.

According to data from the New York Fed, the three rounds of checks have seen progressively less spent and more saved. The figures show a double message: consumers are accumulating their balance sheets, which indicates great purchasing power, but they are also increasingly reluctant to part with these cash.

What economists call the marginal propensity to consume has fallen from 29% in the first round of spring 2020 stimulus controls to 25% in the most recent distribution.

“As the economy reopens and fear and uncertainty are reduced, high levels of savings should facilitate more spending in the future,” New York Fed economists said in a recent report. “However, there is great uncertainty and discussion about the pace of this increase in spending and the extent of accumulated demand.”

In fact, the future of the economy beyond the stimulus-driven boom of 2021 will largely depend on the history of how much people can’t expect to spend after being saved for a year and the time which will last.

Mark Zandi, chief economist at Moody’s Analytics, is more optimistic about the fate of the economy. It predicts a new explosion of activity from the next infrastructure bill, with spending that is unlikely to take root until 2023 and beyond.

“This will lead to self-sustaining economic expansion. There is so much juice that we will return to full employment in the next 18 to 24 months,” Zandi said. “Once that short-term juice runs out, we’ll get another shot.”

However, the economy will have a long way to go in this period.

As always, there is the pandemic. While almost all news about vaccines has been good, a sudden surge in variants could cause some nervous elected officials to block parts of the economy again.

And there is the issue of inflation.

If the Fed does well, it can keep policy loose and growth can continue. If he is wrong, Powell has admitted that the main tool will be interest rate hikes that, while unlikely to stifle recovery, could slow it down significantly. Housing, which has led the economy out of recovery, would be hardest hit.

Saint Louis Fed economist Fernando Martin said a combination of rising inflation expectations, falling unemployment and rising money supply to the economy could apply more inflation lasting than currently suggested by policymakers.

“If these pressures materialize and persist, the Fed will have to move on to reduce inflation and reach its 2% average inflation target,” Martin wrote, although he also said it is possible that the inflation remains low.

There is also likely to be a tax calculation.

In the middle of the fiscal year, the government already has a budget deficit of $ 1.7 trillion, as total national debt recently surpassed the $ 28 trillion level. The public share of this debt is about $ 22 trillion, or 102% of GDP.

The Congress that will run in next year’s midterm elections may want to look more fiscally responsible and therefore stifle the freewheeling spending that will fuel the economy this year to its strongest annual performance since 1984.

Zandi sees a change in policy as perhaps the greatest danger to the long-term economic vision.

“Failure to engage the economy in self-sustaining expansion will lead to a policy error,” he said. “We’re going to have to do something wrong. Either the Fed slows down too hard or fiscal policy makers don’t get any more support.”

This support is essential as the country tries to prevent a recovery that leaves too much of it, Zandi added.

“The risks are considerable. It’s about a K-shaped recovery, income and wealth inequality, racial inequality issues, climate change,” he said. “These are deep problems that I don’t think can be solved without a very complete political response.”