The four scenarios for the US economy
Furman and Powell III foresee four possible scenarios from now and until the end of the year:
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- The Goldilocks scenario: spring and summer mismatches between demand and supply, where high demand cannot be satisfied due to labor shortages, will work themselves out. As a result, price and wage increases will be transitory.
- The overheating scenario: final demand increases sharply while supply remains constrained by labor shortages. This is what happened at the beginning of 2021 where the 9.8 percent annual rate increase in final demand was met from foreign producers and from running down inventories. In this case, a possible outcome is a boom-bust scenario where the Fed raises rates either too high or too fast in an attempt to curtail inflation, financial market turbulence, or the dynamics of demand, and the economy falls into a recession.
- Job short recovery: in this scenario demand returns to normal and supply is able to match it with a combination of longer hours and greater productivity. Real wages rise as labor demand exceeds labor supply at the current wage, leading wages to go up along with productivity. This is actually the Fed’s scenario as presented in the Summary of Economic Projections where output returns to pre-pandemic levels but the unemployment rate remains substantially elevated.
- The return of the virus: if a variant of COVID-19 proves to be resistant to the available vaccines, the US and global economy could end up back in their 2020 situation.
The US labor market is running hot…or not?
By: Jason Furman, Wilson Powell III – Peterson Institute, Harvard University
The US economy is recovering
[T]he US economy is emerging from the pandemic recession with a fundamentally altered inter-sectoral balance. Spending on durable goods currently accounts for an additional 1.7 percentage points of GDP, relative to its 2019 level, and spending on housing construction is running at 0.5 points above its 2019 share. At the same time, business spending on structures and consumer spending on energy are both running at 0.5 points below their 2019 shares, and spending on services (hospitality, recreation, and transportation) is 2.2 points below its 2019 share.
Will these sectoral dynamics lead to higher inflation as firms start to offer higher wages to incentivize workers to switch to the growing sectors of the economy? These wage increases, argues Brad DeLong, are an essential part of rebalancing the economy and the Fed will not allow a transient uptick in prices to become embedded in inflation expectations.
Is the US Economy Recovering or Overheating?
By: J. Bradford DeLong, University of California at Berkeley
The US economy is overheating
Cochrane and Hassett, in this commentary, argue that signs of persistent inflation are emerging. In particular: core inflation and commodity prices are up sharply; inflation expectations have risen; shortages from lumber to semiconductors have raised input prices for businesses; and more and more small companies have a hard time finding workers. In addition, the Fed will be under pressure not to raise interest rates to fight inflation in view of the ballooning Federal debt.
When demand soars and supply is constrained, inflation will rise. When people question policy and find it feckless, they expect more inflation, and inflation grows more and becomes entrenched. Persistent inflation grows suddenly, unexpectedly and intractably, just as it did in the 1970s. Some worry that a burst of inflation will lead the Fed to raise rates and thereby stymie the recovery. It is a far greater worry that the Fed will not react promptly, thereby letting inflation and inflation expectations spiral upwards.
Inflation and expectations at NRO
By: John H. Cochrane, Kevin A. Hassett – Hoover Institute
