May 26 2020
The economic landscape has deteriorated shockingly quick in 2020. Real GDP grew at an annualized rate of 2.1% in Q4 2019, yet declined 4.8% in Q1 2020. The effects of the coronavirus (COVID-19) outbreak were widespread, with nearly all measures of economic activity showing significant declines. Quarterly figures understate the economic destruction that occurred in March, as the impact from measures taken to halt the spread of COVID-19 was muted during the first two months of the year. Conditions have worsened thus far in Q2, with the economy at its weakest standing since the Great Depression.
Nowhere is the fallout of the sudden stop to the economy more apparent than in the labor market. In the week ending May 16, 2.44 million individuals filed initial jobless claims. Since businesses began shutting down in mid-March, a staggering 38.6 million claims have been filed. Despite initial claims declining since peaking at the end of March, they remain significantly higher than at any point since weekly job claims were first recorded in the mid-1960s.
These job losses, while having occurred in every sector, have disproportionately hurt sectors that rely on interactions between people. Most affected has been leisure and hospitality, as total employment in April was down 48.3% since February. The sector has been the most affected by shelter-in-place orders, social distancing and restrictions on nonessential activity, as many of the business models are reliant on human interaction. Personal and other miscellaneous services have also fared disproportionally worse for the same reasons, with employment declining 22.0% since February.
Somewhat paradoxically, real average hourly earnings increased 5.6% from March to April, with average hourly earnings growing 4.7% and the consumer price index declining 0.8%. Unfortunately, this speaks more to where job losses have occurred than to any fundamental shift in wage trends; workers in leisure and hospitality, as well as other services, disproportionately tend to be lower-skill and lower-wage workers. Since job losses have been more extreme in those sectors, their removal from the pool of employed workers has positively skewed average hourly earnings
Job losses and measures taken to impede the spread of the virus have shifted consumer purchasing patterns considerably in 2020. Not only did consumer spending decline 7.5% in March, but spending varied. Spending on services and durable goods declined 9.5% and 15.1%, respectively, while spending on nondurable goods actually rose 3.1% due to increased spending on items such as grocery items, home supplies and other essentials.
The overall decline in consumption has been driven primarily by the measures enacted to halt the spread of the virus, as consumers’ willingness to spend has cratered. As a result, the personal savings rate rose to 13.1% in March, the highest since the mid-1970s, and is expected to increase further in Q2. While the savings rate will decline sharply once material reopenings of regional economies occur, it is not expected to revert back to levels of the last few years until 2022. Moreover, high levels of household indebtedness and unemployment are expected to serve as drags on overall consumption for an extended period of time.
The collapse in consumption weighed on prices in March and April, with apparel, airfare and hotel stays showing significant declines because of the collapse in travel and nonessential activity. The decline in April was particularly severe, as it represented the largest monthly percentage decline since at least the inception of the consumer price index survey. Acting partially as a counterweight is the unprecedented level of stimulus from both monetary and fiscal policy, as the government has attempted to plug some of the holes in the economy created by the response to the health crisis. This has eased some of the deflationary pressure by boosting incomes and providing businesses with much-needed liquidity.
Moving forward, prices are expected to decline further in Q2 before beginning to inch up during the second half of the year. Moreover, a distinct possibility remains of accelerated inflation once the health crisis is over due to the perfect storm that is near-zero interest rates, an unrestricted reopening of the economy and ensuing release of pent-up demand. This is subject to the considerable uncertainty associated with a resurgence of the coronavirus in the fall or winter. Further restrictions on business activity would likely weigh on consumption and increase deflationary pressure within the economy in the short-term.
Reopening the economy
With material restrictions of the national economy having been in place for over two months, the deterioration of the economy has been palpable. Consequently, the urgency felt in the reopening process of regional economies is to be expected. However, each state has to weigh the benefits of reopening the economy versus the risk of overwhelming the healthcare system. Three primary factors stand out in this cost-benefit analysis: the trend of COVID-19 cases and deaths, state testing and contact tracing capabilities, and the ability of hospitals to handle a potential surge of hospitalizations.
In terms of the spread of the coronavirus, daily reported cases and deaths plateaued in the middle of April, with confirmed cases slowing. This discrepancy is potentially a function of increased testing capacity helping identify cases that previously flew under the radar. Much of this decline in cases is due to nonessential business closures, social distancing guidelines, and safer-at-home orders, though there was an obvious economic cost to the measures. Q2 GDP is projected to decline 40.0%, with over 40 million in job losses, year-over-year. The high stakes of a haphazard reopening are clear, as an encore of these economic shutdowns would likely have a severe impact on consumers and businesses alike.
Though cases and deaths have shown a promising downward trend, testing infrastructure remains a challenge for the country. Despite expert consensus indicating that the country must be able to test nearly a million people per day to safely reopen fully, current testing capacity remains a third of that, largely due to supply chain logjams regarding testing swabs and reagent. With these issues expected to persist, some restrictions on economic activity and consumer behavior will likely remain in place indefinitely, as a resurgence of the coronavirus represents the biggest risk to economic recovery.
A key factor behind the decisions to curtail economic activity throughout the country was to prevent the hospital system from being overwhelmed by an influx of COVID-19 patients. Accordingly, it is vital that hospitals throughout the country build surge capacity and stock up on medical supplies such as PPE equipment, as experts believe a fall or winter resurgence is likely. Some states such as New York have mandated preparation for such a scenario, while others will likely be unprepared if a similar wave of cases comes. Considering that one of the biggest drags on GDP growth in Q1 was the restriction on higher-margin elective healthcare procedures, the ability of the system to handle a second wave will have significant implications on the trajectory of economic recovery. In general, the more prepared hospitals are to handle a surge in cases, the more likely it is that further shutdowns of the economy will not be needed.
From the vantage point of the present, where the economy will be in six months is highly uncertain. While regional economies have begun reopening and a sharp rebound is expected in Q3, the economy is far from a return to normalcy. For one, some job losses will unfortunately be permanent. Furthermore, while the government has stepped in to address liquidity issues by expanding access to credit, a solvency crisis may emerge. Many businesses and consumers will likely go bankrupt, though the looming bankruptcy wave can be softened if the federal government provides further fiscal relief in the coming months.
At any rate, a V-shape recovery is highly unlikely. Consumers will likely bear scars from this crisis as it stands, with behavior and preferences shifting in unpredictable ways. The longer the health crisis and corresponding lockdown measures linger, the more permanent and deeper the economic damage will be. The importance of a vaccine to immunize the population is apparent against this backdrop, as it represents the only real way to end this crisis. While early trials of multiple vaccine candidates have shown promising signs, mass distribution of a vaccine remains a challenge.