Here’s a riddle for you: What can be both too hot and too cold at once? The answer is the economy of the United States during the summer of 2021.
That is the common thread that emerges from economic data, financial market shifts, anecdotes from businesses, and the experiences of ordinary people who are simultaneously enjoying higher incomes while also experiencing higher prices and shortages.
Employers are offering higher wages to attract scarce workers in the mid-2021 economy; airports and car lots are bustling; and the Gross Domestic Product (G.D.P.) report due out next week will almost certainly show record growth. Aside from that, it is an economy in which inflation is outpacing wage increases for many workers, the share of the population employed remains far below pre-pandemic levels, and bond markets are priced at levels that indicate a high risk of the economy reverting to sluggish growth in the years ahead.
Essentially, the economy is having a more difficult time rebooting itself than it appeared to be likely during the heady days of spring, when many Americans were getting their flu shots and stimulus payments were hitting bank accounts in record numbers.
The Biden administration and the Federal Reserve are placing their faith in their ability to achieve a smooth transition to an economy that enjoys prosperity while avoiding the frustration of persistently high prices. For that to happen, however, a massive mismatch between the demand for goods and services across the economy and the supply of those goods and services must be addressed. It is not known how long this will take to complete.
As Karen Dynan, a Harvard economist and former official at the Federal Reserve and the Treasury, put it, “I think we should have expected frictions in reopening the economy following this unprecedented shock.” The frictions have been severe, and it is entirely reasonable to expect that the frictions will continue.
Demand for goods and services is extraordinarily high right now, as Americans spend their pent-up savings, government stimulus payments, and higher wages to satisfy their desires. Retail sales increased by 20% last month compared to the same month the previous year.
Businesses, on the other hand, have found it more difficult to increase production in order to meet demand than forecasters had anticipated in the spring. This has been particularly evident in the case of automobiles, where a scarcity of microchips has caused production to be severely constrained.
But supply shortages are evident across all sorts of industries. The latest survey of manufacturers from the Institute for Supply Management cites complaints from makers of furniture, chemical products, machinery and electrical products about the difficulties of fulfilling demand.
As a result, there is significant price inflation, making it difficult to determine whether wage increases are truly benefiting workers. During each of the first six months of the year, average hourly earnings in the private sector increased at a slower rate than the Consumer Price Index.
Because of the unique circumstances surrounding the post-pandemic reopening, those figures are most likely an understatement of the average wage increase experienced by workers, but the gist of the storey is clear: Workers are earning higher wages, yes, but they are also paying more for the goods and services they consume.
Several of these appear to be “transitory” inflationary pressures that are expected to diminish, if not reverse, in the near future. Bottlenecks are set to resolve — lumber prices have fallen sharply in recent weeks, for example, and used car prices may finally be stabilizing at high levels. However, there are also longer-term effects that could have a negative impact on the purchasing power of the dollar for months to come.
Rents are starting to rise sharply, according to a range of data sources. In addition, businesses that are experiencing higher prices for supplies and labour may still be in the early stages of passing on those higher costs to consumers. During June, the Producer Price Index, which tracks the costs of the supplies and services that businesses purchase, increased by 1 percent, marking an acceleration from the previous months. An indication that inflationary forces may still be working their way through the economy is provided by this indicator.
“It has a whiff of stagflation,” said Paul Ashworth, chief U.S. economist at Capital Economics, referring to a combination of stagnant growth and inflation in the economy. “Real growth is not weak, but it is not as strong as we had hoped it would be,” says the economist. Things started out with a lot of optimism, but things have now started to come back to earth a little bit.”
It is the labour market that serves as the most visible example of a market that is both too hot and too cold at the same time.
Businesses are complaining about labour shortages and are offering a variety of incentives to entice workers to join their ranks. Despite this, the unemployment rate is 5.9 percent, which is comparable to a recession. Furthermore, the proportion of adults in the labour force — either employed or looking for work — has remained virtually unchanged for months, failing to make any significant progress toward returning to its pre-pandemic level. It was 63.3 percent in February 2020, but it has been bouncing around between 61.4 percent and 61.7 percent for more than a year and a half.
Individuals may be making logical decisions for themselves not to work in order to save money. Employees in their golden years may choose to retire a few years early, or families may decide to live on one income rather than two. Nonetheless, the low levels of labour force participation will have a cumulative effect on the economy’s productive potential, as shown in Figure 1.
In the background of it all is a great deal of uncertainty about whether the Delta variant of coronavirus will cause a new wave of disruptions to commerce — both domestically and internationally in countries where vaccines are less readily available. That anxiety has contributed to large swings in global financial markets, which are increasingly priced in a way that suggests the years ahead will be less like the roaring 2020s and more like the sluggish 2010s, according to the most recent data.
In the first three months of the year, longer-term bond yields soared and the yield curve — which charts the difference between shorter-term and longer-term interest rates — steepened. Both of these tend to be indicators that investors anticipate higher growth rates in the future.
That has reversed in recent weeks. The 10-year Treasury yield was 1.22 percent Tuesday, down from 1.75 percent at the recent high at the end of March.
What does all of this mean for the economy of the United States, which is both too hot and too cold? Efforts to reopen the economy have yielded positive results, and there is no shortage of demand from Americans who are feeling generous. The economy will not be in equilibrium until prices, wages, output, and demand are restored. Until that occurs, things will not feel quite right.