GDP, unemployment, even inflation look a lot like the prepandemic economy. The big changes are beneath the surface.
WSJ
Suppose you’re an economist who issued a forecast in January 2020 of where the U.S. economy would be in December 2023, then promptly fell into a coma.
This month, you woke up and glanced at the latest economic data. You might not suspect we had been through a traumatic pandemic.
That’s the vibe that comes from comparing the Congressional Budget Office’s predictions from January 2020, shortly before the pandemic, with the forecast it released last week. In the current quarter, the economy will be almost exactly the same size (measured by inflation-adjusted gross domestic product) it predicted four years ago. Well, 0.3% larger, to be precise. Growth averaged 1.8% over the past four years, exactly as predicted. The epic collapse of output in early 2020 and gyrations since canceled each other out.
How about unemployment? CBO figures it should average 3.9% this quarter, a tad lower than the 4.2% projected four years ago.
Surely inflation is higher. But no: CBO thinks the consumer-price index will be up 2.5% annualized in the current quarter, lining up nicely with the 2.4% penciled in four years ago. (The 12-month inflation rate is still higher, at 3.1%; I’ll return to this.)
So, did the pandemic that was supposed to change everything change nothing? Yes and no. The broad contours of the economy indeed changed little. Beneath the surface, though, what we consume, how we work, and where inflation and interest rates will settle have changed, with profound impacts.
When the pandemic first hit, the only useful precedents were natural disasters. As the economy reopened, the supply chain disruptions and labor shortages drew comparisons to the shift from a military to civilian economy following World War II and then back when the Korean War broke out.
While no natural disaster or supply chain disruption compares to the pandemic and its aftermath, the analogies have proven apt, foreshadowing that once the disruptions were over, the economy would go back to the way it was.
At times, the pandemic seemed like it might permanently alter the path of growth. The digitization of work, commerce, medical care and so on offered the potential to boost productivity and long-term growth. In the end, they did not.
There were fears social distancing and virus variants would corrode productivity and drive millions out of the labor force for good, stunting long-run growth. That didn’t happen, either. The labor-force participation rate—the share of people age 16 and over working or looking for work—sank to 61.5% at the end of 2020 from 63.3% a year earlier. Yet by this past November it was back to 62.8%, higher than CBO expected four years ago. The workforce got a bit younger as elderly workers left and immigrants entered.
The bottom line: the CBO and Federal Reserve now put long-run U.S. growth around 1.8%, close to what they saw four years ago.
Not long ago a repeat of the 1970s seemed possible when supply shocks, empowered workers and inflationary psychology kept pushing inflation higher, forcing the Fed to tighten until a recession began.
In fact, it looks like the pandemic caused a spectacular one-time rise in the level of prices but no wage-price spiral or de-anchoring of inflation expectations, both necessary for a sustained higher inflation rate (how fast prices rise per year).
To be sure, inflation hasn’t been defeated; in the year through November, it was 4% excluding food and energy. Yet in a year, markets expect inflation to hit 2.3% then average 2.2% through 2030, based on the yields of regular and inflation-indexed bonds analyzed by Barclays. The simple explanation: the Fed insisted it would eventually return inflation to its 2% target, and investors believed it.
Inflation dynamics have changed in one critical way. Between the global financial crisis in 2008 and the pandemic, inflation averaged 1.6%—well below the Fed’s target. Markets believe those days are over. This also explains one glaring difference Rip Van Economist would have noticed upon waking this month: interest rates. The Fed’s target rate, at 5.3%, is 3 percentage points higher than he predicted four years ago, and bond yields are more than a point higher (which is why mortgage rates are higher and houses so unaffordable).
Last week the Fed signaled it will start to cut interest rates next year. To determine where they end up, Benson Durham of Piper Sandler breaks down yields on Treasury securities, adjusts them for technical factors, and concludes the market sees short-term interest rates settling around 3% by 2029, higher than at any point in the decade before the pandemic.
This suggests that the decade before the pandemic was an anomaly as depressed demand after the financial crisis kept inflation and interest rates near zero. The pandemic jolted the economy out of that stagnation, returning inflation and interest rates to a low, but not abnormally low, path.
These macroeconomic data points, of course, obscure huge changes in the nature of economic activity and work. People are more likely to work remotely, from home, and for less hours. This has profoundly changed social relationships, family priorities, and even how we spend: consumption today is more skewed toward goods than services. The virus no longer controls our lives but it’s still with us, as is the knowledge of how easily everything we take for granted can be turned upside down.
