The increasing growth of the US economy and falling inflation are dampening fears of recession
The European economy, which is being held back by Germany's unusual weakness, is barely growing. China is struggling to regain its sizzle. And Japan continues to disappoint.
But in the United States it's a different story. Here, the surprisingly strong economy is outperforming all major trading partners despite consumers' ongoing fears of inflation.
As of 2020, the United States has weathered a once-in-a-century pandemic, the highest inflation in 40 years, and the fallout from two foreign wars. After posting faster annual growth last year than in 2022, the US economy is now allaying fears of a new recession while offering lessons for future crisis management.
“The U.S. has come out of this really strong and is moving forward when Covid never existed,” said Claudia Sahm, a former Federal Reserve economist who now runs an eponymous consulting firm. “We deserve it; It wasn’t a coincidence.”
On Friday, President Biden welcomed new government data showing annual inflation fell back to the Federal Reserve's 2 percent target in the second half of 2023. Combined with Thursday's news that the economy grew 3.1 percent over the past 12 months, the Commerce Department report showed the United States appears to have achieved an economic soft landing.
The post-pandemic recovery challenged long-standing economic beliefs, such as the idea of an inverse relationship between unemployment and inflation. (While one rose, the other was expected to fall.) Expressed in what economists call the Phillips curve, this panacea proved almost useless in explaining the economy's recent behavior.
Washington's success in reviving the economy also suggests a new approach to future downturns, one that relies more on the government's power over the purse strings and less on the Federal Reserve's control of borrowing costs.
“If you put money in people's hands instead of changing interest rates, which is monetary policy, fiscal policy will be stronger,” Sahm said. “We can't go into the next crisis and say, 'Oh, the Fed has this under control.'”
Consumer spending is driving the economy: Real consumption rose 0.5 percent in December, the strongest pace since last January. Pending home sales also skyrocketed. After the deluge of good news, economists at JPMorgan Chase said they had raised their first-quarter growth forecast.
IBM, Visa and General Electric each reported profits last week that beat analysts' expectations, another sign of the economy's continued health.
The $28 trillion U.S. economy has weathered multiple shocks over the past year and returned to the growth path it was on before the pandemic. The inflation-adjusted economic size returned to its pre-pandemic peak at the beginning of 2021. By the end of September, it was more than 7 percent larger than before the pandemic. According to the British Parliament, this was more than double Japan's increase and significantly better than Germany's paltry 0.3 percent increase.
For most Americans, the growth paid off in the form of higher wages. In the four years to September, according to the most recent available comparison, wages in the US rose – after inflation – by 2.8 percent.
Most other countries in the Group of Seven industrial democracies recorded declines, according to the Finance Ministry. Italian wages fell by more than nine percent during this period, while German workers earned 7.2 percent less than before the pandemic.
“The US has seen a particularly strong GDP recovery and inflation has cooled earlier and faster than in other large, advanced economies. And the rise in real wages is unique to our nation’s recovery,” Treasury Secretary Janet L. Yellen said in a speech in Chicago last week.
The origins of this calamitous performance can be traced to lawmakers' rapid response to the coronavirus pandemic in March 2020. Before the end of the month, Congress approved more than $2 trillion in relief measures for the economy as businesses closed and 17 million Americans lost their jobs.
That was just the beginning of Washington's uncompromising response to the worst economic crisis since the Great Depression. Congress ultimately approved around $6 trillion to rescue the economy from the pandemic. According to the Committee for a Responsible Federal Budget, Presidents Donald Trump and Biden both took administrative actions such as suspending student loan payments, adding an additional $875 billion to the rescue fund.
The Fed helped by lowering borrowing costs for consumers and businesses and purchasing trillions of dollars' worth of government and mortgage-backed securities to stimulate the economy.
However, the main force of today's robust economy lies in fiscal policy, the use of government spending and taxes to stimulate growth. Under two presidents — one Republican and one Democrat — lawmakers chose to shower the economy with cash to fend off the coronavirus.
According to the International Monetary Fund, all of this government spending – the stimulus packages, the loans to small businesses and the expansion of unemployment benefits – added up to a staggering 25.5 percent of gross domestic product.
Large European and Asian countries spent significantly less. In Germany, the government spent 15.3 percent of GDP on fighting the pandemic. France spent 9.6 percent and Italy 10.9 percent. Even Great Britain, which is closest to American economic views, lagged far behind the United States at 19.3 percent of GDP.
“The level of fiscal support for the U.S. economy was an order of magnitude larger than in Europe,” said Neil Shearing, chief economist at Capital Economics in London.
To be sure, the American response to the crisis was not without its flaws. Determined to avoid the policy failures that led to the anemic recovery after the 2008 financial crisis, Biden may have overcompensated.
The latest burst of coronavirus aid, the $1.9 trillion American Rescue Plan in early 2021, has boosted growth but is widely seen as a factor in the price surge that pushed inflation to a 40-year high of 9.1 percent.
The rescue plan included $1,400 stimulus checks for most Americans, increased unemployment benefits and aid to state and local governments. According to several studies by economists, the American Rescue Plan, which supplemented a separate $900 billion program in December 2020, was responsible for two to four percentage points of the increase in inflation.
The emergency aid to the struggling economy also sent the national debt soaring to a new high of $34 trillion, or more than 120 percent of annual economic output, posing a long-term threat to the country's prosperity, according to some economists.
As the pandemic eased, Biden secured additional legislative successes on infrastructure, subsidies for the semiconductor industry and clean energy projects. These were not designed as stimulus programs, but rather had that effect by sending additional flows of money into the economy, according to Dean Baker, an economist at the Center for Economic and Policy Research.
“These began to take effect last year as the impact of the initial stimulus measures faded. I realize it was mostly luck, but it was incredibly good timing,” he said.
The United States benefited from high-spending and fast-moving politics. But Europe suffered from being closer to the front in Russia's war against Ukraine. Before the conflict broke out in February 2022, countries like Germany relied on Russia for much of their natural gas needs. The war led to a huge increase in the prices of food, fuel and fertilizers, which caused inflation to skyrocket in the euro area.
Europe's response to the economic crisis generally required that companies receiving government aid keep their workers on the payroll. While Americans were laid off but then supported by unemployment and stimulus packages, Europeans stayed on the job.
This spared them the uncertainty of labor market limbo, but often forced them to take jobs that were not needed in the post-pandemic world.
For years after the 2008 crisis, President Barack Obama — under pressure from a Republican Congress — accepted the need to reduce federal spending. This left the Fed alone to combat economic weakness. Next time, thanks to the pandemic experience, the nation's gaze may turn to Capitol Hill.
One lesson from the recovery from the pandemic is the power of the government's ability to tax and spend, economists said. Congressional action can have a faster impact on the economy than the lagged effects of a change in borrowing costs and is more certain than the results of other, less conventional Fed actions designed to stimulate growth.
“Fiscal policy is where the government can really influence the speed of recovery from a downturn,” said former Fed economist Michael Strain, now at the American Enterprise Institute. “There are a million caveats.”
Not every economic downturn requires massive government intervention, and any programs implemented should be well designed and carefully monitored. In the rush to release Covid aid, for example, the Small Business Administration paid out more than $200 billion in potentially fraudulent business loans and related aid, the agency's inspector general reported last year.
That is more than the annual budget of the Ministry of Transport.
Some economists see more than just government policy behind the U.S. recovery. When the pandemic left millions of Americans unemployed almost overnight in the spring of 2020, many responded by launching new business ventures.
This trend has been going on for four years. In December, 457,316 applications for tax identification numbers were submitted to the Internal Revenue Service, compared to 314,337 in December 2019.
“I think we're seeing something about the American spirit and the kind of economic dynamism that, for whatever reason, doesn't exist in other high-income countries to the same extent that it does here,” Strain said. “One of the most interesting things happening in the economy now and in recent years is the great boom in entrepreneurship.”
Comments are closed.