Reassessments and Reconsiderations Heading into 2021
With our December U.S. Economic Outlook we are reassessing our letter grade for the outlook and the balance of risk. The medium-term outlook is improving. The balance of risk is less dominated by the scourge of a new plague. The prospect for at least two highly effective vaccines delivered and administered in the U.S. within a few months is a game changer, putting a floor under downside risk and eliminating our worst fears.
However, the vaccines will not arrive in time to stop the current surge in COVID-19 cases seen across most states. Some hospitals are filled to capacity, others are dangerously close. Consequently, states and cities are tightening social mitigation policies. The economic and social burden of this round of social policy tightening appears to be concentrated on bars, restaurants, entertainment venues and households with school-aged children. Also, auto sales moderated in November to a 15.9 million unit rate according to the BEA. Weaker sales this winter would weigh on automakers and their supply chains.
So, while we show risks as balanced, that is too simplistic. Near-term downside risks are elevated, but so too are medium-term upside risks. We still have to get through a dark winter before we see the green shoots of spring.
Recent economic data aligns with our expectation that GDP growth through the fourth quarter has slowed dramatically following the historic third quarter rebound. A cogent way to describe the fourth quarter is “transitional.” We are transitioning from the rollercoaster shutdowns and re-openings of the second and third quarters into something else. This transitional period is largely shaped by the successes and failures of the massive policy levers required in these extraordinary times.
We expect headline real GDP growth to look more or less “normal” over the next few quarters, namely, low single digits. However, these are not normal times. Further tightening of social mitigation policies, loss of confidence and policy blunders could weigh further on economic growth, pulling the transitional economy back into contraction in the first quarter of 2021. The good news here is that there is already fiscal and monetary policy “medicine” in the system. More fiscal stimulus is expected early in the Biden Administration. Also, the real medicine of the vaccines is coming. There is a lot of pent-up demand waiting to be spent out when conditions feel more normal. This potent combination will be a circuit breaker, significantly reducing the potential for downside momentum spilling into the second quarter of 2021 and beyond.
We look for strong GDP in the second half of 2021 as we put the coronavirus nightmare behind us. Even with strong GDP growth, we expect to be left with a lingering high unemployment rate. The Federal Reserve has said that they will not preemptively increase the benchmark fed funds rate as the economic cycle warms up. They will wait until significant progress has been made in lowering the unemployment rate. Therefore, we expect interest rates to remain low through 2021 incentivizing business investment, residential investment and auto sales.
It is appropriate to think about the cost of the massive amount of fiscal stimulus that was brought to bear this year, and will likely be added next year. We often express the increase in federal debt as a ratio to GDP. There is justifiable concern that the debt-GDP ratio may be heading into perilous territory. It is possible to scale the debt differently to show that it may be less perilous than previously thought. A recent discussion paper* by Jason Furman and Larry Summers argues that debt-to-GDP is the wrong measure. They favor gauging federal debt against discounted sum of future GDP. The paper is worth a read and may provide insight into the future relationship between fiscal and monetary policy as we emerge from this historic challenge.
*A Reconsideration of Fiscal Policy in an Era of Low Interest Rates, Furman and Summers, The Brookings Institute, November 30, 2020.
For a PDF version of this publication, click here: December 2020 U.S. Economic Outlook
