Is the US economy too hot or too cold? Yes.
Here’s a riddle: what is too hot and too cold at the same time? The answer: the US economy in the summer of 2021.
It is the common thread of economic data; changes in financial markets; business anecdotes; and the experiences of ordinary people who simultaneously enjoy higher incomes and face higher prices and shortages.
In the midst of the 2021 economy, employers are offering higher wages to attract scarce workers; airports and car parks are lively; and a GDP report expected next week will likely show successful growth. It is also an economy in which inflation exceeds wage gains for many workers; the share of the working population remains well below pre-pandemic levels; and bond markets are valued at levels which suggest a high risk of a return to sluggish growth in the years to come.
Essentially, the economy is having a harder time restarting than it had seemed likely during the heady days of spring, when many Americans were getting vaccinated and stimulus payments hit current accounts.
The Biden administration and the Federal Reserve are betting they can achieve a smooth transition to a prosperous economy without frustrating inflation. But for that to happen, a huge mismatch – between the demand for goods and services across the economy and the supply of them – will need to be resolved. It is not known how long it will take.
“I think we should have expected friction in reopening the economy after this unprecedented shock,” said Karen Dynan, Harvard economist and former head of the Federal Reserve and Treasury. “We have seen serious friction, and it is entirely reasonable to expect that this friction will continue.”
Consumer demand for goods, and increasingly services, is unusually high, as Americans spend their accumulated savings, government stimulus payments and higher wages. Retail sales increased 20% last month compared to June 2019.
But companies have had a harder time ramping up production to meet this demand than forecasters expected in the spring. This has been particularly evident in the case of cars, where a shortage of microchips has limited production.
But supply shortages are evident in all kinds of industries. the last survey of Manufacturers of the Institute for Supply Management cites complaints from manufacturers of furniture, chemicals, machinery and electrical products about difficulties in meeting demand.
This generates price inflation high enough that it is ambiguous whether the wage increases really benefit workers. Average hourly earnings in the private sector grew faster than the Consumer Price Index in each of the first six months of the year.
Due to the unique circumstances of the post-pandemic reopening, these numbers most likely underestimate the wage increase a typical worker experienced, but the bottom line is clear: Workers earn higher wages, yes, but also pay more for the things they buy.
Much of this appears to be “transient” inflationary pressures that are expected to abate and, in some cases, reverse. Bottlenecks are about to disappear – lumber prices have fallen sharply in recent weeks, for example, and used car prices could finally stabilize at high levels. But there are also slower effects that could reduce the purchasing power of the dollar for months to come.
Rents are starting to rise sharply, within a range of information source. And businesses facing higher prices for supplies and labor may be in the early stages of passing those higher costs on to consumers. The producer price index, which tracks the costs of supplies and services purchased by businesses, rose 1% in June, an acceleration from April and May. This is a signal that inflationary forces may still find their way through the economy.
“We call it a whiff of stagflation,” said Paul Ashworth, chief US economist at Capital Economics, using the term for a combination of stagnant growth and inflation. “Real growth is not weak, but it’s just not as strong as we thought. There was a lot of optimism, and now things are coming back to earth a bit. “
The labor market is the clearest example of a market that is both too hot and too cold.
Companies complain about labor shortages and offer all kinds of incentives to attract workers. Still, the unemployment rate is 5.9 percent, similar to a recession. And the share of adults in the workforce – who are working or looking for work – has been essentially stable for months, having made no clear progress to return to its pre-pandemic level. It was 63.3% in February 2020 but has rebounded between 61.4% and 61.7% for more than a year.
Individuals can make rational choices for themselves not to work. Older workers may retire a few years earlier, for example, or families may decide to get by on one income instead of two. But overall, low levels of labor market participation will limit the productive potential of the economy.
Much uncertainty hangs over all of this as to whether the Delta variant of the coronavirus will create a new wave of trade disruptions – both domestically and abroad in places where vaccine availability is lower. This concern has helped cause big swings in global financial markets, whose prices are increasingly valued in ways that suggest that the years to come will be less the roaring 2020s and more similar to the gloomy 2010s.
In the first three months of the year, long-term bond yields soared and the yield curve, which marks the difference between short-term and long-term interest rates, steepened. Both of these tend to indicate that investors expect higher growth rates in the future.
This has been reversed in recent weeks. The 10-year Treasury yield was 1.22% on Tuesday, down from 1.75% at the recent high in late March.
Where does it all leave the US economy too hot and too cold? Much work has been done to reopen the economy, and there is no shortage of demand from satiated Americans. But until the economy finds a new balance between prices, wages, production and demand, things will not go well.