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Economic Impact: Strong Growth in 2021, Weaker After That

This article was published in the Richmond Times Dispatch on January 11, 2021.

Forecasting is never easy, but throw a pandemic in the mix and it becomes even more difficult.

As usual, the assumptions behind a forecast are critical to its accuracy.

In forecast for this year, we assume:

  • A vaccine is widely distributed in the United States in the second quarter;
  • Deaths and infections related to the coronavirus start to decline in February or March as predicted by the University of Washington's COVID-19 Model;
  • The Biden administration’s economic agenda reflect Democratic priorities; and
  • Additional coronavirus-related stimulus is forthcoming along with extended unemployment benefits.

Strong GDP Growth in 2021

These assumptions point to a strong economy in 2021, but weaker growth after the COVID-related stimulus works its way through the economy in the years following 2021.

The record levels of stimulus the federal government and Federal Reserve provided in 2020 to offset some of the damage caused by shuttering of some businesses to prevent the spread of the coronavirus boosted real quarterly gross domestic product growth to an annualized 33.4f% in the third quarter after a sharp annualized decline of 31.4% in the second quarter.

Fourth quarter GDP won’t be released until Jan. 28. If it increases at a 1.5% annualized pace as predicted, then real GDP for 2020 would contract 3.7%.

We predict relatively strong real GDP growth of 3.5% to 4.0% in 2021 with the first half of the year supported by the anticipated stimulus funding and the second half bolstered by citizens who have been vaccinated feeling more comfortable about eating at restaurants, visiting retail establishments and traveling.

Weaker Growth After 2021

But we’re not forecasting a Roaring 20s similar to what the U.S. experienced after the 1918 pandemic.

After the stimulus and recession rebound are complete, economic growth will revert to its potential growth rate, which varies over time and is dependent on productivity and labor force expansion.

A simple way to estimate the potential growth rate is to add the annual productivity growth rate, which was 1.4% from 2009 through 2019, with the labor force growth rate of 0.5 percent during that same period.

As a result, the potential growth rate of real gross domestic product was 1.9% during that period.

That is much slower than the 2.4% average potential GDP growth rate from 2003 through 2008 and the 3.2% rate from 1992-2002.

During those periods, productivity growth averaged a faster 1.5% during 2003 through 2008 and 2.0% in 1992-2002. The labor force grew an average annual 0.9% in the 2003-2008 period and 1.2% from 1992 to 2002. 

Congressional Budget Office Estimates

Looking ahead, the Congressional Budget Office is estimating productivity to grow 1.4% and the labor force to advance 0.4% a year from 2020 through 2030.

That would equate to a potential growth rate of 1.8 percent a year.

The CBO estimate was influenced by Trump administration policies of reduced regulations and taxes, which both support productivity growth. It is possible that the Biden administration will reverse some of those policies, leading to slower productivity growth.

Changes in GDP are closely related to changes in household income and standards of living enjoyed by Americans. In any case, the current CBO projections indicate that growth in living standards could be much slower over the next decade than it was over the last half century.

What Will the Federal Reserve Do?

In addition to predicting changes in living standards, the difference between the potential growth rate and projected GDP growth is considered by the Federal Reserve when it decides whether to try to speed up or slow down economic growth to meet its long-term goals.

The Federal Reserve tends to increase the overnight interest rate that banks charge each other, known as the federal funds rate, when the economy is consistently growing faster than it potentially should or inflation is too high. The Fed also lowers this rate when the economy is growing too slow.

In light of the damage the pandemic inflicted on the national economy, Federal Reserve officials have indicated that they will keep the federal funds rate at essentially zero until at least 2023.

 

Christine Chmura is CEO and chief economist at Chmura Economics & Analytics. She can be reached at (804) 649-3640 or receive e-mail at chris@chmuraecon.com.

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