The COVID-19 recession brought to the fore some very unusual and puzzling patterns between different macroeconomic aggregates, with supply side bottlenecks and shortages, record consumer inflation and the unusual coexistence of an unusually tight labour market altogether with record labor slack. The COVID recession itself lasted only two months according to the NBER's Business cycle Committee. A double dip recession seems relatively improbable despite the threat posed by new COVID-19 variants.
In this regard, it should be noted, as Fed Chair Jay Powell recently pointed out, that although the COVID-19 virus and its multiple variants are still around the progress of vaccination campaigns, the availability of more efficient treatments and changing individual behaviours have significantly increased the ability of human societies to cope with the virus and to minimise its human and economic toll. This has been observed in most advanced and emerging economies even though the level of resilience of healthcare systems and the containment of the virus have been uneven across different countries and within each country, amid "beggar thy (ill) neighbour" policies that have stymied the efficacy of the global fight against the pandemic.
The fiscal and monetary response to the pandemic has corrected some of its most dire human and economic consequences but it has also led to new imbalances and it has magnified some of the imbalances that existed prior to the pandemic, such as the mounting trade frictions and the chronic shortages of raw materials and electronic components that have weighed on the growth performance of different countries and industries. The combined impact of all these imbalances, direct and indirect effects of the pandemic on supply and demand have shaped a very peculiar COVID-19 related business cycle, giving rise to what one might call "the COVID-19 conundrum".
Reading the latest US GDP figures
COVID checks, Real Disposable income and Personal Consumption Expenditures
Looking at the evolution of Personal Consumption Expenditures (PCE) in the wake of the pandemic's first waves and the subsequent response to it, one very unusual pattern emerges that is at odds with what happens in the wake of the recession. Indeed, while PCE plunged in March-April 2020 as a result of the lockdown with all categories of consumer expenditures experiencing a declining - especially services and durable goods. From the chart below, it can however be seen that after the initial COVID induced negative demand shock, there has been a strong, above trend, rebound in the consumption of goods - with the consumption of durable goods rebounding much faster and stronger than the consumption of non durable goods. This rebound has managed to compensate the persistent slump observed in the consumption of services against its pre-crisis level (not to say against its pre-crisis trend).
According to a study conducted by two Cleveland Fed economists (cf. Tauber, Van Zandweghe (2021), the increase in durable goods spending observed during the pandemic is the combined result of two factors : "Two likely possibilities are that the historic change in consumers’ circumstances altered what they wanted to buy and that an increase in their disposable income due to fiscal policy measures changed how much they could buy." Indeed, as the authors point out, one explanation for the unusual behaviour of durable goods spending during the pandemic is that lockdowns and social distancing shifted consumer demand away from services toward durable goods. The other explanation is that an increase in disposable income resulting from fiscal policy measures stimulated consumption expenditures, including those on durable goods.
Overall, according to the authors each explanation accounted for about half of the increase in durable goods purchases in 2020, although the relative importance of each effect varies for different types of durable goods. Purchases of recreational goods, such as consumer electronics and sporting equipment, likely increased primarily because households used these goods as substitutes for services during the most acute phases of the pandemic when they were ordered to stay at home. In contrast, motor vehicle purchases likely benefited from the unusually higher disposable income, resulting from three rounds of massive fiscal support (April 2020, January 2021, March 2021). Indeed, if anything the use of transportation means, be they public or private, decreased during the pandemic.
The first pandemic-related substitution effect is quite understandable, although it has been at first minored and overshadowed by the sharp reduction observed in consumer expenditure on services. The second, policy-related, income effect might be explained by the Keynesian general theory of consumption which states that households consumption is primarily a function of their current income, through a coefficient called the marginal propensity to consume (MPC).
In order to assess the latter, Tauber and Van Zandeweghe ran a panel regression that related the growth in durable goods spending in each of the 50 US states to the state’s growth in personal income, controlling for state and time fixed effects. The analysis yielded an estimated MPC for durable goods PCE in 2020 is 0.6, indicating that an additional dollar of income raises durable goods purchases by 60 cents. The MPC is somewhat larger for motor vehicles and for furniture and appliances. Indeed, as the authors state " the predicted contribution from income growth, which captures the indirect effect of the pandemic on durable goods spending growth, amounts to 2.8 percentage points or almost half of the growth in durable goods PCE. The major types of durable goods show some notable differences. Income growth boosted motor vehicle purchases and accounted for the majority of the increase in purchases of furniture and appliances, but it accounted for only a small portion of the increase in purchases of recreational goods."
This approach drawing primarily on Keynes consumption theory has been challenged by the late Milton Friedman, who stated in his 1957 ground-breaking essay, A Theory of the Consumption Function that, beyond non discretionary items like food and energy, the overall level of households consumption is determined by their expectations of future income, through what Friedman called the "permanent income hypothesis", rather than by their current income, which is stochastic by nature. Friedman's ground-breaking ideas have been further developed and refined by other economists, including Franco Modigliani who mixed demographics with economics through his "life-cycle hypothesis".
Who is right, Keynes or Friedman?
In an Oped published earlier in June, in Project Syndicate, John Taylor - the author of the famed Taylor rule of monetary policy - and a long time critic of Keynesian policies argued that, the fiscal stimulus did not work this time around, again, as in 2008.
Our own analysis suggests that the answer to the above question lies somewhere in between but that overall the transitory nature of the fiscal stimulus has clearly been understood by US households. The first stimulus has been absorbed and "neutralised" by the aforementioned substitution effect. in economic terms the efficacy of the first stimulus checks has been disputed by many economists, as these checks did not and could not "stimulate" demand in the sectors that have been the most affected by the pandemic. The second and third waves of COVID fiscal stimulus in the US have led to far above trend demand in durable goods, as our charts above show. In turn this helps explain the observed surge in the prices of durable goods (cf. the next section), which has been hastily and falsely qualified by some commentators as the resurgence of a broad-based and self-sustained inflationary momentum (cf. our analysis of the June CPI inflation figures).
The total Real Disposable income of US households excluding transfers is still around 5% lower than what would be inferred from extrapolating the pre-crisis trend. This is related to the prevailing gap still observed in private payrolls against their pre-crisis baseline. Hence, the fiscal stimulus has indeed supported the recovery of private consumption. But a significant part of the checks that households have received from the Federal Government has been saved.
Going forward, our model-based forecasts suggest that PCE won't contribute to a strong headline GDP growth in H2 2021 as the pick up of consumption in services could be balanced by a significant slowdown in the consumption of both durable and non durable goods.
In an alternative scenario (cf. scenario 2 below) we would see a new round of fiscal stimulus announced in fall 2021 by the Biden Administration and supported by Congress. This would provide a boost to private consumption and could lead to higher growth figures in H2 2021 but this will in turn also depend on the turn taken by monetary policy as the employment gap is progressively being closed.
In any case, GDP growth beyond the 4.9 percent carryover effect realised in H1 2021 will have to be supported by other drivers, namely gross private investment (inventories and non residential fixed investment) and net exports. A GDP growth rate of 6.5 percent or higher can still be expected in the 2021. We are more concerned by the uncertainty clouding the macro outlook for the US and for the global economy in 2022-2023, amid indications that COVID-19 is going to become endemic and to continue mutating.
Consumer demand, supply bottlenecks and price surges
The COVID conundrum can also be observed in the shifting relationship between the demand for durable goods demand and their prices (cf. the chart below). Indeed, the strong negative correlation that prevailed between the short run change in the prices of durable goods around their long run trend and personal consumption expenditures of durable goods in the pre-COVID period has temporarily turned positive . In normal times, demand reacts to prices, hence the negative correlation and the observed cyclical pattern around a secular trend of falling prices for durable goods. But in 2020-2021, it is the other way around with inelastic supply leading to prices reacting strongly to above trend demand. This conundrum is nevertheless starting to ease with the demand for durable goods softening on account of higher prices and the fading impact of the fiscal stimulus.
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