Contrary to a negative picture inferred from recent market volatility, the economy begins the new year in good health after a robust fourth quarter. This strength comes despite conspicuous headwinds such as a new Covid strain, disfunction in Washington, Russian threats, and increasing concerns over inflation.
In the final quarter of 2021, real gross domestic product surged 6.9%. This was a marked acceleration from the third quarter’s 2.3% pace and helped push the full-year growth rate to 5.7%, the highest calendar year expansion since 1983.
As is often the case, growth has been uneven in terms of industry and region. This effect has been magnified during the pandemic due to cycles of restrictions and reopening, some national, many local. When we last wrote, the Delta variant was the main driver. The day after Thanksgiving, news came out of a new strain emerging from South Africa that was significantly more contagious. Fear of the potential impact was manifest in a one-day 900-point drop in the Dow Jones Industrial Index.
Thankfully, the Omicron variant appears to present milder symptoms than prior Covid genomes. Still, due to its transmissibility, records are being broken in terms of new cases and hospitalizations. Business has been affected, if modestly so. For instance, industrial production rose 3.7% last year and it now sits 0.6% higher than its pre-Pandemic level. But it dipped 0.1% in December. Similarly, consumer confidence rose strongly in the first half of the year but tapered as Delta and Omicron dealt their respective blows.
Bringing these broad strokes to the personal level, we find that jobs are plentiful, bodies to fill them are not quite sufficient, and prices seem to be rising faster than wages.
Regarding the latter, inflation increased throughout 2021. In December, the year-over-year change in consumer prices hit 7% while average hourly wages rose just over 6%. There are several factors driving this acceleration, including supply chain disruptions and a tight labor market, particularly at the lower end of the wage scale. Many of the supply chain issues appear transitory in nature, though each additional wave of infection fosters new ones.
Meanwhile, the tightness of labor seems somewhat intransient. In December, the unemployment rate fell to 3.9%, well down from its peak of 14.7% in April 2020, but still above its pre-pandemic rate of 3.5%. Still, there are roughly four million fewer people in the workforce versus two years ago, despite population growth of about three million during the same spell. This lower labor participation rate is influenced by enhanced unemployment benefits, adding to the upward pressure on wages and prices. As these enhanced benefits expire, wage pressures should moderate.
The desire to increase employment while keeping inflation under control presents difficulties to policy makers. Often, programs that increase activity also stimulate inflation, while measures intended to suppress inflation tend to impede growth as well. President Biden has been pushing his Build Back Better (BBB) plan, which includes near term spending to stimulate jobs, but also tax provisions which would likely do the opposite. There does not appear to be enough support in the Senate for BBB to pass, and existing measures such as the child tax credit payments appear unlikely to continue. This could result in net reduced government spending. Countering this is a declining savings rate, as consumers spend funds accumulated during the pandemic.
The Federal Reserve can act more decisively, but it faces a similar dilemma in addressing its occasionally conflicting mandates of promoting maximum employment, stable prices, and moderate interest rates. As we reported in prior reports, the Fed cut rates to near zero in wake of the pandemic. As the economy regained its footing, the Fed adjusted policies and buying programs to allow rates to rise back toward ‘normal’. But upon new waves of Covid infection and stock market drops, the Fed slowed the pace of normalization. As long as inflation is higher than target, the northward direction of rates will likely continue. But the speed and pattern of rate increases, and the injection or withdrawal of liquidity, will likely depend on political and biological events which at this point are very unpredictable.