US risks repeating post-GFC mistakes as economic rebound slows

Trillions of dollars in federal aid to households and businesses have allowed the US economy to emerge from the first six months of the coronavirus pandemic in far better shape than many observers feared last spring.

But that spending has now largely dried up, and hopes for a major new aid package before the November 3 election are all but dead, even as the virus persists and millions of Americans remain unemployed. Already, there are signs that the economic rebound is losing steam as some measures of consumer spending growth decelerate and job gains slow. Applications for jobless benefits rose last week, with about 825,000 Americans filing for state unemployment benefits.

Republicans and Democrats remain far apart on a new federal aid deal, raising concerns about permanent economic damage.Credit:Bloomberg

The combination of a moderating economic rebound and fading government support are an eerie echo of the weak period that followed the 2007-2009 recession. In the view of many analysts, a premature pullback in government support then led to a grinding recovery that left legions of would-be employees out of work for years. In recent weeks, prominent economists have warned that both the United States and Europe, where many early responses are drawing to a close, are at risk of repeating that mistake by cutting off government aid too soon.

Leaders of both US major political parties have expressed support, at least in theory, for additional aid. But the parties remain far apart on a deal, with Democrats pushing for a large package and Republicans arguing that a smaller plan will suffice.

The ability to reach a compromise in the coming weeks has been further complicated by a looming confirmation battle to replace Ruth Bader Ginsburg on the Supreme Court.

"That's my great concern — that we're going leave and not have a stimulus COVID package put together," Republican Senator Roy Blunt, said on Thursday (US time). "I just think the Supreme Court thing used up a lot of oxygen. We'll see. I'd like to see us get this done."

A stalling recovery when we're stalling at near the worst point of the Great Recession is a terrible outcome

One factor making an agreement even less likely: The economic revival is slowing, but not as sharply as some economists predicted would happen once expanded unemployment insurance and other programs began to ebb.

Job growth slowed in July and August but remained positive. Consumer spending, which rebounded sharply once federal money started flowing in April, has likewise seen a more gradual rebound but has not fallen. Layoffs, as measured by claims for unemployment insurance, have continued to trend down, although they remain high by historical standards.

But many economists said that allowing the economy to slow at the current moment — with millions out of work or underemployed — could lead to long-term economic scarring. Employers have still hired back less than half of the 22 million workers they laid off in March and April, and the unemployment rate is higher than the peak of many past recessions. Even optimistic forecasts imply that gross domestic product will shrink more this year than in the worst year of the last recession.

"A stalling recovery when we're stalling at near the worst point of the Great Recession is a terrible outcome," said Tara Sinclair, an economist at George Washington University.

Jerome Powell, the Federal Reserve chair, made clear during congressional hearings this week that the economy, while recovering, would likely need more support.

"The power of fiscal policy is unequalled by really anything else," Powell said during testimony before a House subcommittee Wednesday. "We need to stay with it, all of us," he said, adding, "The recovery will go faster if there's support coming both from Congress and from the Fed."

Eric Rosengren, president of the Federal Reserve Bank of Boston, said Wednesday that additional fiscal policy "is very much needed" but noted it "seems increasingly unlikely to materialise anytime soon."

Some economists warn that the economy could begin to shrink again if Congress doesn't act. Many households were able to save in the spring, thanks to federal aid and shutdown orders that kept them from spending money on restaurant meals and hotel stays. Households socked away about one-third of their disposable incomes in April, and while the savings rate has come down since, it remained sharply elevated from pre-crisis levels through July. That should create some buffer.

Economists fear removing federal aid too quickly will bring the economic rebounding grinding to a halt.Credit:Bloomberg

But those funds won't sustain jobless families indefinitely now that extra unemployment benefits have expired and a partial supplement supported by repurposed federal funds is on the brink of running out. And businesses that were kept afloat during the summer may struggle when colder weather puts an end to outdoor dining and other activities.

There are important differences between the two crisis eras, especially in the United States. The economy was far stronger before the pandemic hit than in 2007, when inflated home prices, risky lending and financial engineering left the banking system vulnerable. And policymakers responded far more quickly and aggressively this time around.

The Fed cut interest rates close to zero in March, before data showing widespread economic damage had even begun to emerge. In the last crisis, the Fed didn't take that step until the end of 2008, a year after the recession had begun. The European Central Bank rolled out massive bond-buying programs, something that monetary policymakers in the currency block resisted in the immediate aftermath of the 2009 crisis.

But central banks have less room to adjust their policies to bolster growth now than they did a decade ago. Interest rates and inflation have fallen to low levels across advanced economies, stealing potency from monetary policy tools that work by making credit cheap.

That's where fiscal policy — elected officials' ability to tax and spend — comes in. Economic theory suggests that fiscal policy can be effective at times when monetary policy is not.

Initially, policymakers across advanced economies seemed far more willing to spend heavily and amass huge deficits than they were during the last crisis, at least in part because the same low interest rates robbing central banks of their power have made payments on government debt cheaper.

In the early days of this crisis, Congress approved legislation that sent direct payments to most US households, established a small-business assistance program that eventually handed out more than a half-trillion dollars in grants and low-interest loans, and added $US600 a week to unemployment checks, while simultaneously expanding the unemployment system to cover millions more workers. Together, the programs dwarfed the response to the last recession.

The aggressive response was successful. After shedding millions of workers in March and April, companies began bringing them back in May and June. Stimulus checks and enhanced unemployment lifted personal incomes in April and May, buoying spending. A predicted wave of foreclosures and evictions largely failed to materialise. By August, the unemployment rate had fallen to 8.4 per cent, defying expectations that it would remain in double digits into next year.

Jerome Powell made it clear during Congress testimony this week that the US economy needs continual Federal support. Credit:AP

While Powell said that government spending so far should get "credit" for that outcome, risks loom if key programs are allowed to permanently lapse. As unemployed workers run through their savings, they might pull back on spending, evictions and foreclosures could increase, and the fallout could scar the economy, he said during testimony on Thursday.

"There's downside risks to the economy probably coming if some form of that support does not continue," Powell said.

While the Fed has pledged to keep rates low and is operating a variety of programs meant to keep credit flowing to households and businesses, those are not a substitute for direct federal spending.

Economists said Powell appears to have learned a lesson from the aftermath of the last recession: When the Fed is forced to try to rescue the economy on its own, the result is a painfully slow recovery that takes years to reach many of the most vulnerable households.

The New York Times

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