Borrowing-Fueled Fiscal Stimulus A ‘Serious Concern’; Labor Market Lag Persists in California, Across Nation

Pandemic Recession was Deepest and Shortest in U.S. History as Output Jumps to Pre-Covid Levels; Near Term Forecast Strong but Long Run Instabilities Loom

In the 2nd quarter of 2021, real economic output in the United States pushed higher than pre-pandemic levels, making the COVID-induced recession the shortest in the nation’s history. According to Beacon Economics’ latest outlook for the U.S. and California, although the recession ‘officially’ ended in May 2020 (peak to trough), it will take another quarter or so for output to return to its sustainable, long-run trend. The new analysis finds that output would have already recovered to trend but for supply chain issues and labor shortages that are preventing it from catching up with demand.

While aggregate U.S. output has recovered, other parts of the economy, including the all-important labor market, are still lagging their pre-pandemic levels. In the case of the labor market, however, this is due to structural changes that have occurred throughout the crisis.

“This is not the same economy it was a year and a half ago, structurally, financially, or demographically,” said Christopher Thornberg, Founding Partner of Beacon Economics and one of the forecast authors. “The labor market has probably rebounded as much as it can given today’s labor supply.”

Although there are still 6.75 million (or 4.5%) fewer jobs in the nation than there were prior to the pandemic, the problem is one of labor supply, not demand. For the last two months, there have been 9.2 million job openings in the United States, 20% more than the highest-ever reading back in 2018. “We’ve had a big decline in the number of people in the active labor force as many workers have left or retired voluntarily,” said Thornberg. “This supply problem is at the heart of the labor market’s slow recovery and indicates that workers are not only doing better than they did in the aftermath of the Great Recession but in some ways, are doing better today than they did in the months prior to the pandemic.”

Like the nation, many parts of California’s economy have also returned to pre-pandemic levels, and in some cases, have recovered to their former trend. “It’s safe to say that California’s economy is now producing as much output as it did before the pandemic hit,” said Taner Osman, Research Manager at Beacon Economics and one of the forecast authors. “And we’re doing it with over a million fewer workers.”

According to the outlook, in addition to the supply-side dynamics occurring across the nation, productivity gains have replaced thousands of jobs in California. While this may appear to be a negative development for workers, labor demand remains high in the state. “Although productivity gains can replace jobs in the short term, productivity growth is the lifeblood of economic expansion over time,” said Osman.

As for the biggest threat to the economy, both in the U.S. and California, the new outlook points to a looming, but longer-term, hazard: the massive amount of monetary and fiscal stimulus the Federal government hosed out across the economy throughout the crisis. While the stimulus very likely hastened the recovery, the huge injection of money comes at a serious cost and could introduce dangerous instabilities into the next expansion. These include inflation and asset bubbles, a deepening of the nation’s long-run fiscal budget challenges, and possibly laying the seeds for the next downturn. “The Federal Reserve has consistently suggested the current run-up in prices is largely transitory,” said Thornberg. “While this may be true, it does not mean that longer-run systemic inflation is not a serious risk.”

According to the new outlook, the near-term economic forecast boils down to a strong run over the next couple of years (with labor supply being the biggest constraint), but with long-term storm clouds on the horizon. U.S. GDP is expected to grow by 6.7% in the 3rd quarter, falling to a more sustainable 4.9% in the 4th.

Additional Key Findings:

• Housing inventory in California has fallen to unprecedented levels. Currently, there is a mere 1.8 months’ worth of home supply available on the market (a balanced market has about 6 months of supply).
  
• Vaccination rates in the state have surpassed national levels, and while the trajectory of California’s economy could be influenced by the coronavirus in the very short-term, it would amount to a slight slowing of growth rather than an economic contraction.
  
• The pandemic-driven Federal stimulus has created an excess in household savings across the United States to the tune of $2 trillion – cash that has been used to pay debt, invested, or saved.
  
• Due to booming home prices and a stock market bubble, aggregate household net worth has grown 23% in the United States, its most rapid year-over-year pace – ever.

View the newly designed The Beacon Outlook here.