The American economy, while never simple, was at least somewhat understood — until the pandemic upended even the most basic assumptions, experts told The Hill this week.
From the recession that didn’t happen, to the relationship between unemployment and inflation, to the reason that inflation took off in the first place, to the disconnect between national economic performance and people’s experience of it, to the efficacy of interest rate hikes — American economics and the people who follow it are having an identity crisis.
It’s not clear how it’s going to resolve.
Some economists feel vindicated by what they’ve seen play out, while others have changed their positions. Others have suggested entirely new models are needed and have encountered pushback from colleagues on that suggestion as well.
But no matter how you frame it, it’s undeniable that where there once was confidence, now a fretful mood has descended over a discipline trying to reconcile long-held dogmas with the near-wartime economic conditions brought on by the pandemic and the sensational recovery that followed.
“What you have is a shake-up of economics here in the United States, because we’re having a shift again,” Richard Wolff, emeritus professor of economics at the University of Massachusetts Amherst and a visiting professor at the New School, told The Hill.
“It remains to be seen in this episode to what extent the normal relationships of many, many kinds — labor, spending, inflation and others — will go back to their pre-pandemic norms, or will be permanently perturbed,” former Federal Reserve Vice Chairman Alan Blinder, a Princeton University economist, told The Hill.
Blinder, who oversaw a period of quantitative tightening in the mid-1990s during the Clinton administration, said the very efficacy of monetary policy is now up for debate.
A quasi-wartime economy plays by different rules
Economists see the end of World War II, when debt-to-gross domestic product (GDP) ratios were about as high as where they are today and inflation was above 10 percent, as a point of comparison for the economy of today.
“The only real precedent that I can identify to the pandemic-era exertion of state control over the economy would be the two world wars,” Daniel Sargent, a professor of the history of public policy at the University of California, told The Hill in an interview.
“It’s also significant that some of the statutory authority that the federal government leaned upon in order to exercise the degree of control that it did derived from [the] Trading with the Enemy Act of 1917,” Sargent added.
While the economy of the 1970s also experienced a series of state interventions, including price controls as part of the “Nixon shock” intended to resolve inflation, the deficit spending of the pandemic makes the post-World War II period the most relevant analogue for today’s economy, Sargent said.
The sudden switch to such a high level of state intervention is likely a central reason that many traditional assumptions have broken down.
The comparison to the post-WWII period was also top of mind for Harvard University economist Stephen Marglin.
“During the pandemic, the same thing happened [as during the war]. There weren’t the civilian goods being produced, and people did get money, but they couldn’t spend it because the economy was shut down, just like the civilian economy had been shut down during WWII. That’s the analogy,” he told The Hill.
Marglin said that a doctrinal shift within economics akin to those that reshaped the discipline in the 1930s and again in the 1970s “probably should happen” but that he wasn’t seeing any immediate signs of a major course correction.
Causes of inflation spark debate but unite major thinkers
While the nation’s current battle with inflation has sparked a small industry of rhetorical debate, many experts The Hill spoke to said there’s an implicit agreement among different camps that stitches the different arguments together.
Republicans and conservative economists tend to argue that inflation was caused primarily by the trillions in deficit spending the government sent out to bolster households and businesses during lockdowns.
Democrats and liberal economists focus on muddled supply chains and even corporate greed as the primary drivers.
But the private-sector response to the public-sector spending spans both these explanations, economists say.
“What we had was a situation in which corporations across America understood that the money pumped into the economy to cope with the crash that we were due to have, coupled with the pandemic, was an extraordinary time. The government pumped in enormous amounts of money, enormous amounts of fiscal stimulus, and this made it possible to raise prices to improve profitability,” the New School’s Richard Wolff said.
While the cash injection into the economy made it possible for companies to raise their prices, it also allowed people to keep spending money, helping to stave off recession.
“The central view, I feel, is totally vindicated,” Hoover Institution economist and former University of Chicago finance professor John Cochrane told The Hill. “The central reason we got inflation is the government printed up about $3 trillion and borrowed another $2 trillion, and sent people checks.”
“That’s also consistent with why inflation eased, even without the Fed really doing anything,” he added. “It did not repeat 1980 to 1982 when interest rates were well below inflation even after the Fed started raising them. A one time fiscal blowout raises the price level, so you get a burst of inflation that eventually goes away.”
So why haven’t we seen a recession?
“A US recession is effectively certain in the next 12 months,” Bloomberg News reported in October of last year, citing its own economic model.
“The latest recession probability models by Bloomberg economists … forecast a higher recession probability across all timeframes, with the 12-month estimate of a downturn by October 2023 hitting 100 percent,” the economists found — erroneously.
Some big-time financial players got swept up in the groupthink on recession.
Bank of America CEO Brian Moynihan predicted a “mild recession” in 2023, and JPMorgan Chase CEO Jamie Dimon said a “hurricane” was forming over the economy.
Even the Federal Reserve predicted a “mild recession” in March before pulling that call later in the year.
Those economists could be forgiven for their confusion: Usually, after a central bank raises interest rates by more than 500 basis points, which makes financing more expensive for both businesses and consumers, the economy slows down.
Not so in 2023. Quarterly GDP growth has exceeded 2 percent for the last five quarters, rising as high as 5.2 percent annualized in the third quarter. Corporate profits have been through the roof.
Princeton’s Alan Blinder said the channels by which the Fed slowed the economy in the mid-1990s seem to have dried up during the current cycle.
“I can tell you for sure, though we didn’t relish enunciating this, that what we thought we were doing is slowing the economy down by putting the squeeze on the auto industry and housing. Neither of those channels seem very much to have worked this time,” he said.
Dean Baker, an economist with the Center for Economic Policy and Research, told The Hill much the same thing.
“It didn’t work through the usual channels,” he said, specifically citing new housing starts, which were relatively unresponsive to Fed rate hikes, as well as an unexpectedly strong performance of net exports.
Severed links between employment, inflation and interest rates
Perhaps the most central relationships that have been thrown into doubt are those between the rate of inflation, the level of interest rates and the level of employment.
Higher and rising prices are correlated through labor costs with higher levels of employment. And higher interest rates, which squeeze the economy, are associated with lower employment and therefore lower prices.
But as the Fed raised rates, and the annual inflation rate descended from 9 percent to just above 3 percent over the past year and a half, unemployment stayed below 4 percent the whole time. This breaks the rule.
“[Rate hikes] didn’t have the effect that just about any of us expected. If you told me the Fed was going to raise rates to 5.25 percent and the unemployment rate was going to remain under 4 percent, I wouldn’t have believed you,” Baker told The Hill.
Does Wall Street reflect America’s real economy anymore?
Surging profitability within the economy, which reached its highest level after the pandemic since the 1920s as a share of gross domestic income, has done little to raise the public’s economic mood.
Profits from current production increased $105.7 billion in the third quarter, compared with an increase of $6.9 billion in the second quarter, Commerce Department data released last week shows.
About 58 percent of Americans own stock in Wall Street companies, according to the Fed’s latest survey of consumer finances.
But that ownership is overwhelmingly skewed toward the extremely rich. In fact, the 99th to 100th percentile of richest households own the majority of all corporate equities in the U.S., a distribution that took off after the pandemic and is near a record high.
While the top 1 percent owns more than half of the stock market, the bottom 50 percent owns less than 1 percent of it.
That may be why just 19 percent of U.S. adults rate economic conditions as excellent or good “while 46 percent say conditions are only fair and 35 percent rate the economy as poor,” as public opinion researchers at Pew found earlier this year.
Despite many ostensibly excellent metrics spanning employment, GDP and decelerating inflation, public approval of President Biden’s economic stewardship is low. Only 32 percent of Americans think Biden is doing a good job with the economy, according to Gallup.
While wage growth has just about kept pace with price growth over the pandemic, longer-term trends in income distribution are almost certainly adding to Americans’ melancholy.
While the profit share of the economy hit 8.5 percent in 2022 and has been generally rising since around 1990, the share of the economy devoted to paying workers has fallen dramatically since 1970, dropping from about 51.6 percent on national income to 43.1 percent now.
“We really do need additional tools for combatting supply chain issues and excess demand. The reliance on this one sledgehammer of Federal Reserve interest policy is not very good,” Harvard’s Marglin told The Hill.
Traditional divisions between monetary policy, which is handled mainly by the Fed, and fiscal policy, which is handled by Congress, mean that even while the field of economics may be going through a period of change, policymakers may have limited tools to turn those changes into reality.