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Why the US economy might be ready for an unknown era

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The question is whether this rapid rebound can last, freeing the country from the low growth rut it has plowed for most of the past 20 years, or whether it will instead trigger the kind of inflation that does not. has not been observed since the 1970s. Leading economists such as former Treasury Secretary Larry Summers are already warning that potential overheating could lead to another recession.

After 20 years of below average growth, the odds are against a prolonged boom. But the pandemic has catalyzed new thinking on fiscal and monetary policy, creating the most favorable conditions to restore vigorous economic growth for several decades.

In terms of history, this is a unique situation, said Chetan Ahya, chief economist at Morgan Stanley, who recently advised clients to prepare for a rapidly growing, high-pressure economy until the end of 2022 at least.

The Biden administration plans to spend $ 1.9 trillion to support growth on top of the $ 3.7 trillion in federal funds that have flowed since March, virtually helping to secure years of massive government borrowing to boost the economy. economy.

At the same time, the Federal Reserve says it will keep interest rates near zero even if inflation exceeds central banks’ annual target of 2%, making borrowing easier for businesses and consumers. .

Not in 75 years, since the American GIs fought two totalitarian empires, the economy has been simultaneously boosted by so much deficit spending and so much easy money. The economy will receive additional support this year from consumers, who have more than $ 1.6 trillion in excess savings, in part thanks to last year’s stimulus checks, according to Bank of America.

As President Biden seeks congressional approval for further relief from the pandemic, he is planning other measures to boost the economy’s long-term outlook. Administration officials are crafting an ambitious spending program that would provide up to $ 3 trillion for a range of democratic priorities, including infrastructure, clean energy, home manufacturing, and child and senior care.

The U.S. economy, most experts say, clearly needs a boost to recreate the kind of growth that made Americans so prosperous in the latter half of the 20th century. Over the past 20 years, by contrast, the U.S. economy has grown at an average annual rate of just 1.9%, well below the 3.5% figure between 1980 and 2000.

Expanding the workforce, either through immigration or by making it easier for women to return to work and modernizing the country’s infrastructure would allow faster long-term growth, many economists have said. Grow over the next decade at an annual rate of 2.5 percent rather than the lukewarm 1.8 percent pace that the Congressional Budget Office expects to produce nearly $ 11 trillion in additional economic activity.

Policies make the difference, said economist Julia Coronado, president of Macropolicy Perspectives. It is possible to progress towards a higher execution rate.

The current situation bears little resemblance to governments’ response to the 2008 crisis, which produced the most anemic recovery in US history. The Bush and Obama administrations have deployed over $ 2 trillion to save the economy, but a few months after the recessions officially ended in June 2009, the United States began to reduce the federal deficit, which undermined the economic rebound.

The deficit fears that have colored and erased today’s political debates are less powerful. Investors only need 1.3% interest to lend money to the government for 10 years, a third of what they demanded in 2009.

Republican lawmakers continue to warn of lavish government spending. But after agreeing to add more than $ 5 trillion to the national debt under the Trump administration, their complaints may carry less weight.

Biden, in any event, seems determined to avoid repeating the mistake of premature austerity.

Now is the time to do it big, the president told a CNN town hall this week.

The Fed has also revolutionized its approach to managing the economy. For decades, the central bank had believed that if unemployment fell too low, inflation would rise, forcing it to pump the brakes by raising interest rates.

But as the economy recovered from the Great Recession, unemployment fell to its lowest level in half a century without inflation reaching the federal government’s 2% price stability target.

After raising rates in 2018 to avoid price hikes that never materialized, the Fed decided to cut them in 2019. Fed officials also embarked on a nationwide listening tour to hear from communities that do not. had not reaped the benefits of full employment.

In August, the Fed announced that it would no longer be so quick to raise rates. Instead, central bank officials will allow the unemployment rate to fall until inflation exceeds its 2% target for a temporary, but unspecified, period in order to bring more Americans into the workforce. the work market.

The new framework is rooted in the lesson of the last few months leading up to the pandemic, when wage gains began to hit low-income workers who until then had not enjoyed the benefits of the expansion. Fed officials concluded they could do more to tighten the job market than we previously thought possible, said Skanda Amarnath, research director at Employ America, a left-wing think tank.

Still, there are risks in running the economy hot. Summers, who was also an economic adviser to the Clinton and Obama administrations, warned earlier this month that Bidens’ $ 1.9 trillion relief bill could trigger inflationary pressures of a kind we don’t have. seen for a generation.

Olivier Blanchard, former chief economist of the International Monetary Fund, also warned that the legislation is too broad and risks triggering inflation that would lead to a rise in Fed interest rates and possibly an economic recession.

If the demand for goods and services grew too quickly, the pool of unemployed would eventually run out and factories would stretch. Beyond this point, wages and prices might start to climb, repeating the experience of the late 1960s, when President Lyndon B. Johnson refused to choose between the weapons of the Vietnam War and butter. of its national program of the Great Society. In 1969, prices were increasing at an annual rate of 6.2 percent, compared to just 2.4 percent two years earlier.

A similar situation today would almost certainly cause the Fed to raise its benchmark rate, a move that often leads to recession.

Federal Reserve Chairman Jerome H. Powell and former Fed Chairman Janet Yellen, Treasury Secretary, dismissed the concerns. Despite the drop in the official unemployment rate, about 10 million fewer Americans are working today than those who were employed last February. Further congressional help and higher consumer spending could put upward pressure on prices, but it will not be significant or sustained, Powell said.

We are still a long way from a strong labor market with widely shared benefits, the Fed chairman said last week.

But Robin Brooks, chief economist at the Institute of International Finance, an industry group, said financial markets were starting to cause concern. One measure of inflation expectations, the 10-year Treasury break-even rate, has jumped since the November election to 2.2%, its highest level in more than two years.

This thing is screaming, Brooks said. Maybe we were doing too much.

The question is how well the economy is performing below its potential, a measure economists call the output gap. Those worried about the overheating say the economy was operating near its limits before the pandemic struck and would be pushed beyond by the Bidens plan.

CBO says the economy is now about 3% below potential. But using a different calculation, Goldman Sachs this week fixed the spread at 6%.

Trying to estimate potential growth is more of an art than a science, said Megan Greene, chief global economist at the Harvard Kennedy School of Government.

Indeed, over the past two decades, CBO valuers have repeatedly lowered their assessments of the economy’s ability to grow without triggering inflation. Throughout 2018 and 2019, CBO said the economy was operating above its sustainable trajectory. Yet the unemployment rate fell from 4.1% at the end of 2017 to 3.5% in February 2020, while inflation has remained subdued.

A year ago, the economy was largely healthy. The 3.5 percent unemployment rate was nearly half a century in the midst of a record expansion.

The recovery from the pandemic crash, which pushed unemployment to nearly 15% in April, has been faster than expected. Thanks to several federal relief cycles last year, the economy is expected to rise significantly above its pre-covid-19 trajectory later this year and total production will be higher next year than what the economists were waiting before the pandemic, according to Ahya.

But the Bidens Build Back Better program aims to create an economy that surpasses the February 2020 model, with reduced income inequality and greater opportunities for women and disadvantaged minority communities.

There is now an increased focus not only on overall GDP, but on how it spreads across population [and] tackling inequality and racial justice, Coronado said. It’s not just about growth numbers and the stock market.

To make this a reality, additional spending beyond the $ 1.9 trillion relief bill will be needed. Before this legislation even authorized Congress, the administration is talking about a possible $ 3 trillion infrastructure package, which faces an uncertain reception on Capitol Hill.

Launching the economy on a permanently higher trajectory will also require retraining of workers, expanded child care services to allow women forced out of the workforce by the pandemic to return to work, and bridges, ports. and updated broadband connections, Greene said.

As millions of Americans get vaccinated against covid-19 every week, the economy is on the move. Retail sales in January jumped more than 5%, their best result since June, while industrial production rose for the fourth consecutive month.

The whole economy is going to grow in a way we haven’t seen growing in a long time, the president said on Wednesday. Now is the time for us to move.

Rachel Siegel contributed to this report.

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