U.S. Economic Outlook

Does the economy really need another round of stimulus checks?

The outcome of the Senate run-off elections in Georgia effectively handed over fiscal control to the Democrats. This seems to be the main take on both sides of the political spectrum as well as among some of Wall Street's finest. However, it is worth noting that Democratic control of all three branches of government is by the slimmest of margins. And while it should enable President-elect Biden to staff his cabinet as he wishes, we do not expect radical political changes ahead. Instead, the President's slim majority might prove quite conducive to centrist policies. One reason for this is that both parties will want to show some positive outcomes to voters ahead of the mid-term elections in 2022. This environment could potentially foster bipartisan compromises, rather than progressive Democratic dreams that turn readily into Wall Street nightmares.

President-elect Biden may be well aware of the potential opportunity. He has already called for a bipartisan approach to providing another round of pandemic relief money.[1] As long-term advocates of fiscal intervention in this crisis we warmly welcome the additional measures that extend unemployment benefits, support kids and families and direct money to schools and healthcare. Even support for state and local governments, which the current proposal envisages, seems necessary if recent labor-market trends are any guide (Chart 1). In our view, these measures can play an important bridging function, overcoming the negative effects of the pandemic until they eventually fade.

Chart 1: A rebound in state and local government employment is still lacking

202101 DWS U.S. Economic Outlook CHART-1.png

Sources: Bureau of Labor Statistics and Haver Analytics as of 1/14/21

However, the final element of the package, yet another step-up of one-time payments, might have implications far beyond just steering the economy toward calmer waters. It might be politically desirable to trump the departing President Trump in terms of one-time payments. After all, the outgoing President pushed for higher payments of this kind at the eleventh hour, only to falter in the face of Senate resistance from his own party. And it is obvious that citizens on the receiving end of seemingly free money are going to welcome it warmly. But broadly distributed one-time payments do not just support people in need – those directly affected by the fallout from the pandemic – but also those that are currently doing relatively well. This raises the question of whether the payments should be made.[2]

Taking recent history as an example, the payment of "only" 1,200 U.S. dollars per person in April 2020 boosted aggregate personal income by around 11% from the pre-pandemic levels of January 2020 (Chart 2).

Chart 2: Personal income was significantly overcompensated by paying (only) 1,200 dollars

202101 DWS U.S. Economic Outlook CHART-2.png

Sources: Bureau of Economic Analysis and Haver Analytics as of 1/14/21

At that time, however, this bold maneuver did indeed seem justified from an economic point of view. No one quite knew what the economic consequences of the emerging external shock called Covid-19 would be. And payment did the trick, supporting a strong bounce back in the economy in the third quarter of 2020. In line with this, labor markets recovered partly and the current composition of personal income is again dominated by regular sources (e.g. wages). The overall savings rate, however, remains still elevated at around 13% – compared to 7% to 8% before the crisis. Therefore, one might argue that Americans still have lots of reserves available and the question of whether further fiscal largesse is necessary arises.

Surveys show that most recipients indicated they used past payments to cover everyday expenses such as food and rent, or to pay down existing debt.[3] A stunning side effect, however, has been a surge in demand for durable goods – quite in contrast to the trend in consumption of "everyday" non-durable goods (Chart 3).

Chart 3: One-time payments boosted demand for durable goods

202101 DWS U.S. Economic Outlook CHART-3.png

Sources: Bureau of Economic Analysis and Haver Analytics as of 1/14/21

It is consumption of non-durable goods, such as food, that could serve as an indicator of how lower income households are actually doing. Stockpiling in the early phase of the pandemic caused a spike in non-durable consumption. But in October and November, just after extended unemployment benefits ceased to be paid, there was a decline. This might be an indication that low income households, above all, had to make tough decisions. Despite a high overall savings rate and still elevated aggregate income, many people may have fallen into a distressed situation. The one-time payments for all might therefore have been too broadly distributed, ending up in excess demand for recreational goods and household furnishing, rather than making up the income gap and ensuing the everyday survival of citizens in difficulty.[4]

Economic theory suggests excess demand should be reflected in higher prices. This is exactly what we observe already in the case of durable goods (Chart 4).

Chart 4: Excess demand pushes up durable goods prices

202101 DWS U.S. Economic Outlook CHART-4.png

Sources: Bureau of Economic Analysis and Haver Analytics as of 1/14/21

At the same time that the demand for durable goods exploded, their prices – as measured by the Personal Consumption Expenditures (PCE) price index– jumped back into positive territory for the first time since 2011. Service prices, by contrast, followed a cyclical pattern as a consequence of lower demand, trending steadily below their long-term average of just above 2%. As we have outlined on several occasions, once the critical colder months of the year have passed and Covid-19 infection rates might decline, higher emerging demand for services, given reduced capacity, might push their prices up. This rotation toward the old normal could increase the overall price level temporarily above the U.S. Federal Reserve's (Fed's) target of 2%.[5] At the same time, however, there is a risk that a temporary rise in inflation might not prove temporary after all.

The availability of vaccines and their distribution to a wider public could prove a pivotal turning point. Despite all risks, the assumption that the recovery eventually speeds up in the second half of 2021 seems reasonable. Without the suppressing effects of social distancing and a partial closure of service establishments, the fiscal payments intended as a bridge could turn into a major prop for economic growth. Based on our historical analysis of the effects from paying 1,200 U.S. dollars to the broader public, another, even larger round of one-time payments might result in sustained elevated demand for (durable) goods and add fuel to the demand for services. The most likely consequence, higher overall inflation, is likely to be tolerated by the Fed to some extent – given their new average inflation target.[6] But the risk is that their view of inflation as transitory could vanish – especially if the labor-market recovery starts to speed up as well. For 2021 and 2022 we still do not expect the Fed to increase rates. But following recent comments by some Fed officials, tapering the central bank's asset purchases might be discussed sooner than some expected.[7] For now, Fed Chair Powell has put back the lid on the topic, however, not without mentioning that the Fed will fight unwelcome inflation – "No one should doubt that."[8]

Chart 5: Debt to GDP is approaching all-time highs

202101 DWS U.S. Economic Outlook CHART-5.png

Sources: Congressional Budget Office and Haver Analytics as of 1/14/21
* "All federal debt held by individuals, corporations, state or local governments, Federal Reserve Banks, foreign governments, and other entities outside the United States Government less Federal Financing Bank securities."
[9]

We believe a booming economy on the other hand is also the perfect environment in which to consider a more hawkish fiscal stance. Generous spending must be financed somehow, especially when fiscal deficits are approaching historical dimensions (Chart 5). This will most likely be achieved via higher taxes on businesses and wealthier households. Following President-elect Biden's agenda, all this is already in the making. But a centrist political stance suggests that further down the road, spending will be limited. So it remains questionable whether spending billions of dollars on one-time payments now is desirable if they potentially imply higher inflation, higher interest rates and higher taxes – especially when the money might be spent on other economically necessary items, such as infrastructure.

Overview: key economic indicators 

2021

 

 

 

2022

 

 

 

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3

Q4F

GDP (% qoq, annualized)

5.3

6.6

4.9

3.2

2.0

2.0

2.0

2.0

Core inflation (% yoy)*

1.5

1.7

1.8

1.8

1.8

1.9

2.0

2.0

Headline inflation (% yoy)*

1.6

1.8

1.8

1.9

1.9

2.0

2.0

2.1

Unemployment rate (%) (EOP)

6.5

6.3

6.0

5.5

5.3

5.2

5.1

4.9

Fiscal balance (% of GDP) (EOP)

/

/

/

-15

/

/

/

-5

Federal funds rate (%)

0.0-0.25

0.0-0.25

0.0-0.25

0.0-0.25

0.0-0.25

0.0-0.25

0.0-0.25

0.0-0.25

*PCE Price Index
** Forecast

 

1 . https://www.bloomberg.com/news/articles/2021-01-12/biden-aims-for-deal-with-republicans-on-covid-19-relief-package?sref=azxX96EA

2 . We are not the first to follow this line of argument: c.f. https://www.bloomberg.com/opinion/articles/2020-12-27/larry-summers-trump-pelosi-2-000-stimulus-checks-are-a-mistake?sref=azxX96EA

3 . https://www.bls.gov/opub/btn/volume-9/receipt-and-use-of-stimulus-payments-in-the-time-of-the-covid-19-pandemic.htm

4 . It is fair to mention that consumers also rotated away from service consumption in favor of goods – measures to fight the pandemic knowingly prohibit such a kind of activity. But still, more than half of the gains in durable goods consumption cannot easily explain this.

5 . https://www.dws.com/insights/cio-view/charts-of-the-week/cotw-2020/chart-of-the-week-20201009/ and https://dws.com/insights/cio-view/us-economic-outlook/202010-us-economic-outlook/?setLanguage=en&kid=int.20190524.cio_view.all_glob.textlink.internal-sendout.mXZgBTPWJt45HsRNBU2breyW2Qd7j2 and https://dws.com/insights/cio-view/us-economic-outlook/202011-us-economic-outlook/?setLanguage=en&kid=int.20190524.cio_view.all_glob.textlink.internal-sendout.mXZgBTPWJt45HsRNBU2breyW2Qd7j2

6 . E.g. see here https://www.reuters.com/article/us-usa-fed-clarida-inflation/clarida-says-fed-wont-raise-rates-until-its-sees-2-inflation-idUSKBN29I306

7 . https://www.bloomberg.com/news/articles/2021-01-11/fed-officials-see-strong-economic-rebound-fanning-talk-of-taper?sref=azxX96EA

8 . https://www.cnbc.com/2021/01/14/powell-sees-no-interest-rate-hikes-on-the-horizon-as-long-as-inflation-stays-low.html

9 . https://www.treasurydirect.gov/govt/resources/faq/faq_publicdebt.htm#:~:text=What%20is%20the%20Debt%20Held,less%20Federal%20Financing%20Bank%20securities

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