The Macro Outlook for 2021: Where Are We Now, and How Did We Get Here?

THE MACRO OUTLOOK FOR 2021: WHERE ARE WE NOW, AND HOW DID WE GET HERE? James A. Kahn Chair, Economics Department Yeshiva University January 14, 2021 GIC Executive Briefing

1

The Economy Pre-COVID • Through

2019, a record 126-month expansion • Fed had been gradually tightening • contracted • reduced • raised

• A brief

bank reserves

the Fed Funds rate target

storm in September 2019

• liquidity • yield

its balance sheet

problems in repo market after Fed

curve inversion, which often signals trouble ahead

2

Passing Storm in 2019 Yield curve inversion

Source: Federal Reserve Bank of St Louis

3

The Economy Pre-COVID • Through

2019, a record 126-month expansion • Fed had been gradually tightening • contracted • reduced • raised

• A brief

its balance sheet

bank reserves

the Fed Funds rate target

storm in September 2019

• liquidity

problems in repo market after Fed • yield curve inversion, which often signals trouble ahead • Fed

reversed course 4

Fed Reverses Course in Fall 2019

QE3 QE2

QE1

Begins to expand balance sheet after nearly two years of very gradually shrinking it 5

Fed Reverses Course in Fall 2019

Reduces Fed Funds rate target after four years of increases 6

Economic Picture is Rosy Heading into 2020 • Brief

storm passed, solid growth continued into February • Job

growth averaging over 200,000 per month • 2019 GDP growth of 2.3% • Unemployment rate fell over 2019 from 4.0 to 3.5%

7

Rosy Economic Picture Heading into 2020 Yield curve reverts

Source: Federal Reserve Bank of St Louis

8

Rosy Economic Picture Heading into 2020

Credit risk spreads remain narrow

Source: Federal Reserve Bank of St Louis

9

Rosy Economic Picture Heading into 2020 • Storm

passed, solid growth continued into February • Job

growth averaging over 200,000 per month • 2019 GDP growth of 2.3% • Unemployment rate fell over 2019 from 4.0 to 3.5% • Then…

10

Pandemic Impact on Employment and Output Output and Hours (2020Q1 = 100) 105

100

Output

95

Hours Trend

90

85

Labor hours

Output

•

•

fell almost 15% in first half of 2020

fell 12.3% in first half

11

Pandemic Impact on Employment and Output Output and Hours (2020Q1 = 100) 105

100

Output

95

Hours Trend

90

85

Labor hours

Output

• •

• •

fell almost 15% in first half of 2020 with recovery in Q3, cumulative decline was 4%

fell 12.3% in first half down 7.4% through Q3 12

Pandemic Impact on Employment and Output Output and Hours (2020Q1 = 100) 105

100

95

Output Hours

90

Trend

85

• Productivity (output/hour) increased, but not how we want it to!

• Output has only recovered about 60% of where it was trending pre-COVID 13

Strong Fiscal and Monetary Response • Fiscal

Stimulus

• Direct

payments to individuals • Loans to businesses • Direct aid to specific industries (health, airlines) • Monetary Stimulus • Massive expansion of Fed Balance sheet through asset purchases • Unprecedented intervention in bond markets • Near zero interest rates (again)

14

Fed Asset Purchases Expand Balance Sheet

• Comparable proportionally to 2008, but much larger in absolute terms: A $3 trillion expansion • Effectively a $3 trillion lending program

15

Immediate Cut in Fed Funds Target

16

Larger Expansion of the Money Supply vs 2008

This time the Fed and legislated lending programs have encouraged banks to lend out money 17

What was the intent of these policies?

• Not

primarily to increase GDP in 2020

• Economic

activity was held down by fiat • But impact was very uneven • “V-shaped” recovery mainly result of reopening, not monetary/fiscal policies • Policies

only make sense as means of keeping individuals and businesses from “failing” • fundamentally

solvent businesses going bankrupt through no fault of their own • individual bankruptcies, foreclosures

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What was the intent of these policies?

• Like

eminent domain: Condemn a property for a public purpose, compensate owner • Idea is to help speed the recovery once activity is allowed to start up again businesses can just “turn on the lights” • Individuals will still have their homes, credit scores • Pre-existing

• Nonetheless,

many failures have occurred, programs are uneven and haphazard • Recovery may be slow • Inflation is more of a risk now than after 2008 19

Pandemic Impact on Employment and Output Output and Hours (2020Q1 = 100) 105

100

95

Output Hours

90

Trend

85

20

Pandemic Impact on Employment and Output Output and Hours (2020Q1 = 100) 105

100

95

Output Hours

90

Trend

85

Recovery likely slowed in Q4 and will continue to slow in Q1: • “Low hanging fruit” has already been taken • Winter resurgence of virus and lockdowns • Room for sustained recovery with Q2/Q3 reopening • Market optimism: Stock market high, yield curve upwardsloping

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The End