The pandemic, and now the war in Ukraine, has changed the way the US economy functions. As economists have waited months for conditions to return to normal, they are beginning to wonder what “normal” will mean.
Some changes are noticeable in everyday life: working from home is more popular, burrito bowls and road trips cost more, and buying a car or sofa made abroad is more difficult.
But those are all symptoms of broader changes plaguing the economy — changes that could be a major problem for consumers, businesses and policymakers alike if they persist. Consumer demand has been high for months, workers are desperately wanted, wages are rising rapidly and prices are rising at the fastest pace in four decades as powerful purchases collide with coiled supply chains. Interest rates are expected to rise higher than at any time in the 2010s as the Federal Reserve tries to rein in inflation.
History is full of great moments that changed America’s economic trajectory: the Great Depression of the 1930s, the Great Inflation of the 1970s, and the Great Recession of 2008 are examples. It’s too early to know for sure, but the changes happening today may turn out to be next.
Economists for the past two years have expected many of the pandemic-era trends to turn out to be temporary, but that hasn’t been the case yet.
Forecasters predicted that rapid inflation would ease in 2021, only to thwart those expectations as it accelerated instead. They thought workers would re-enter the workforce when schools reopened after pandemic closures, but many are left on the sidelines. And they thought consumer spending would slow as the government’s pandemic aid controls faded in the rearview mirror. Shoppers have persevered.
Now Russia’s invasion of Ukraine threatens the global geopolitical order, yet another shock disrupting trade and the economic system.
For Washington policymakers, Wall Street investors and academic economists, the surprises have left an economic mystery with potentially far-reaching consequences. The economy had been rocking slow and steady growth for decades, clouded by sluggish demand, interest rates chronically flirting with troughs, and tepid inflation. Some wonder if that paradigm could change after repeated shocks.
“For the past quarter of a century, we’ve had a perfect storm of disinflationary forces,” said Fed chairman Jerome H. Powell, in response to a question during a public appearance this week, pointing out that the old regime had been disrupted by a pandemic, a major spending and monetary policy response, and a war that created “unmentionable” economic uncertainty. “If we get out of that on the other side, the question is, what’s the nature of that economy going to be?” he said.
The Fed began raising interest rates this month in an attempt to cool the economy and temper high inflation, and Mr Powell made clear this week that the central bank intended to keep raising them — perhaps aggressively. After a year of unpleasant price surprises, he said, the Fed will set policy based on what happens, not on an expected return to the old reality.
“Nobody is sitting at the Fed, or anywhere as far as I know, just waiting for the old regime to come back,” Mr Powell said.
The prepandemic normal was one of chronically weak demand. Today’s economy faces the opposite problem: demand has ramped up and the question is if and when it will moderate.
Previously, globalization had suppressed both wage and price increases, as production could be moved abroad if it became more expensive. Rising inequality and an aging population both contributed to a build-up of savings, and as money was held in safe assets rather than used more actively, it seemed to weigh on growth, inflation and interest rates in many advanced economies.
Japan had been stuck in a regime of sluggish inflation and slow growth for decades, and the trend seemed to spread to Europe and the United States by the 2010s. Economists expected these trends to continue as the population ages and inequality persists.
Then came the coronavirus. Governments around the world have spent huge amounts of money getting workers and businesses through lockdowns — the United States spent about $5 trillion.
The era of lack of demand came to an abrupt end, at least temporarily. The money, which continues to flow into the U.S. economy from consumer savings accounts and state and local treasuries, helped buy strongly as families picked up goods like lawn mowers and refrigerators. Global supply chains couldn’t keep up.
The combination drove costs higher. When companies discovered they could raise prices without losing customers, they did. And when workers saw their grocery and Seamless bills go up, airline tickets soar and kitchen renovations get more expensive, they started asking their employers for more money.
Businesses were hiring again as the economy reopened from the pandemic and to accommodate the consumption spike, so labor was in high demand. Workers started getting the pay raise they wanted, or left for new jobs and higher wages. Some companies began passing on rising labor costs to customers in the form of higher prices.
The world of slow growth, moderate wage growth and low prices evaporated — at least temporarily. The question now is whether things will return to their prepandemic pattern.
The argument for a return to prepandemic standards is simple: supply chains will eventually catch up. Shoppers have a lot of money in savings accounts, but those inventories will eventually run out, and higher Fed interest rates will further slow spending.
As demand declines, the logic goes, forces like aging and rampant inequality will plunge advanced economies back into what many economists call “secular stagnation,” a term coined to describe the economic slump of the 1930s and revived. by Harvard economist Lawrence H. Summers in the 2010s.
The war between Russia and Ukraine and the world economy
Fed officials usually think there will be a return. Their estimates suggest that low inflation and sluggish growth will be back in a few years, and that interest rates don’t need to rise above 3 percent to reach that moderation. Market prices also suggest that inflation will slow over time, albeit to higher levels than investors expected in 2018 and 2019.
But some of the current trends seem to be lingering, at least for a while. There are many vacancies, but the population of working age is steadily growing, immigration has declined and people are only gradually entering work from the sidelines of the labor market. Labor shortages are accelerating wage growth, which could support demand and allow companies to demand higher prices.
Given that some policymakers and economists have said there is a chance that the economy is at a turning point.
It is possible that “the massive fiscal and monetary intervention in response to Covid-19 has moved the economy towards an equilibrium with higher pressures and higher inflation, with people earning and spending more than before,” Neel Kashkari, president of the Minneapolis Fed , wrote in a recent essay.
Global forces could exacerbate those trends. The supply chain problems of the past year could inspire companies to start producing more domestically, reversing the years of globalization and removing a force that has suppressed wage and price growth for decades. The transition to greener energy sources can stimulate investment, raise interest rates and at least temporarily eliminate costs.
“The long era of low inflation, suppressed volatility and easy financial conditions is coming to an end,” Mark Carney, a former head of the Bank of England, said in a speech on the global economy on Tuesday. “It is being replaced by a more challenging macro dynamic in which supply shocks are just as important as demand shocks.”
The Russian invasion of Ukraine, which has the potential to improve global trade relations for years to come, could leave a more lasting mark on the economy than the pandemic did, Mr Carney said.
“The pandemic marks a turning point,” he told reporters. “The bigger story is actually the war. That is the crystallization – amplification – of a process of deglobalization that had begun.”
Mr Summers said the current period of high inflation and repeated supply shocks marked “a period rather than an era”. It is too early to say whether the world has fundamentally changed. In the longer term, he estimates the probability that the economy will settle back into the old regime is about 50-50.
“I don’t see how anyone can trust that the secular stagnation is over for good,” he said. On the other hand, “it is very likely that we would have more demand than before.”
That demand would be fueled by government military spending, spending on climate-related initiatives and spending driven by populist pressure, he said.
Either way, it could take years to know what the economy of the future will look like.
What is clear at this point? The pandemic, and now the geopolitical upheaval, has rocked the economy like a snow globe. The flakes will eventually fall – there will be a new equilibrium – but things can be arranged differently when everything settles down.
