The parking lot of our local high school is fortified by great ranges of speedbumps. These ancient mounds of asphalt were erected in the distant past by school authorities, presumably in tribute to the precision and focus demonstrated by our town’s youngest drivers. Over the years, these speedbumps have contributed to jarred nerves, spilt cups of coffee and scraped mufflers, and they have been roundly cursed by teachers, students and parents alike. However, it must be said that, by slowing down our most enthusiastic and least experienced drivers, they have served a useful purpose.
The summer of 2021 has seen more than its fair share of speedbumps on the road to pandemic recovery. The Delta variant, combined with low vaccination rates, has pushed Covid-19 infections once again to over 150,000 confirmed cases per day, slowing the service sector recovery. Severe supply shortages have cut into light vehicle sales and other consumer and business spending. And a steady wave of grim news concerning Afghanistan, hurricanes and wildfires have eroded consumer confidence.
These are all negatives and there is untold human pain in the stories that are broadcast on the evening news each night. The only slight silver lining is that, going into this summer, the biggest threat to the U.S. economy and financial markets was that the recovery would be so rapid and so strong as to cause the economy to overheat. The speedbumps we have encountered this summer have significantly reduced this risk.
This is particularly evident as we look further on out. Every year, at about this time, I extend my short-term macroeconomic model out a further year. And looking forward, not just at next year but out to 2023, it now appears more likely that the economy will glide down to a slow-but-steady expansion.
There are, of course, plenty of risks to this view. The Delta variant may not represent the last assault by the virus and worsening fatalities could reverse some reopening trends. The global economy may also be more sluggish in the near term, either due to Covid or policy choices made by governments overseas. The forecast presumes some further fiscal stimulus from the passage of both the infrastructure bill and a trimmed-down reconciliation bill by the end of the year. Any political stalemate that results in a fiscal “cold turkey” could put the economy in recession, as would a failure to raise the debt ceiling. Asset prices are high by historical measures and a sharp correction could undermine economic growth. Or some other, as yet unimagined factor could injure the expansion. The history of the last 20 years serves as a reminder of the potential for entirely unanticipated shocks to profoundly alter the direction of both the nation and financial markets.
That being said, the biggest question mark still hovering over the recovery is the balance between demand and supply, and our recent problems have reduced the risk of excess demand leading to runaway inflation and interest rates.
Changing Sources Of Demand
The first step in producing a macroeconomic forecast is sizing up the components of demand, namely, consumer spending, investment spending, government spending and net exports.
Following back-to-back quarters of more than 11% annualized growth, we now expect consumer spending to grow by less than 3% in the third quarter. One big reason for this has been supply-chain issues, which has decimated auto inventories, causing consumers to postpone vehicle purchases. However, the Delta variant has likely also had a significant direct impact, slowing the recovery in the leisure, entertainment and hospitality industries, and contributing to a sharp fall in consumer confidence.
Going forward, we expect confidence and spending to revive as the latest pandemic wave wanes and reopening continues. In addition, while job growth may be slower going forward, we expect wage gains to be strong and this should be supplemented by a continuation of tax credits and other federal government aid. Finally, it should be noted that consumer finances are in unusually strong shape, with big gains in home values and financial assets.
Investment spending should be a major driver of economic growth over the next two years. Construction spending may be somewhat constrained by a slow return to the office and the effects of the lingering pandemic on retail, lodging, entertainment and recreational space. However, investment spending on equipment and software should be very strong, as businesses try to deploy laborsaving equipment in a higher-wage, low-interest-rate environment. In addition, rebuilding inventories should provide a significant boost to the economy, perhaps spaced out over most of the next two years, as global manufacturing slowly works through supply-chain issues.