FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 9, 2021

IN THIS ISSUE:

1. CBO Raises Its Economic Outlook For 2021

2. GDP To Reach Pre-Pandemic Level By July 1

3. Years To Get Economy Back To Full Potential

4. Fed Will Tolerate Post-Pandemic Inflation Spike

5. Final Thought: Why Do We Need More Stimulus?

Overview – CBO Raises Its Economic Outlook For 2021

On February 1 last week, the Congressional Budget Office (CBO) released its latest round of economic forecasts for 2021, and most of the new estimates are stronger than the CBO’s previous forecasts in July of last year.

The CBO said its latest forecasts are stronger because the recession in the first half of last year was not as severe as previously reported, and the recovery which began in the second half of 2020 has been stronger than previously estimated.

Furthermore, the CBO said it expects the US economy to fully recover to its pre-pandemic size by the middle of this year and predicts GDP growth will average 4.6% for all of 2021, following the loss of 3.5% in 2020. The CBO also predicted the US unemployment rate will continue to fall from 6.7% currently to 5.3% by the end of this year and continue falling over the next several years.

While the latest CBO projections are viewed as mostly positive, not all the news was good. For example, while the CBO believes the economy will be back to pre-pandemic levels by mid-year, the agency also believes it will be several more years before the economy is back to its full potential, had the pandemic not occurred. I’ll explain this as we go along today. Let’s jump in.

CBO: US GDP To Reach Pre-Pandemic Level By July 1

The Congressional Budget Office released it latest economic forecasts on Monday of last week, and there were some surprises in the report. As noted above, the CBO predicted US Gross Domestic Product will rebound to its pre-pandemic level by mid-2021. That was a pleasant surprise.

The agency further predicted that GDP will be humming along at an annual rate of 4.6% by the end of this year – without more government stimulus (more on this below). And the CBO now estimates US GDP fell 3.5% in 2020, which is less than its previous forecast in July of last year. Two more surprises.

If US GDP growth does improve to 4.6% this year, as the CBO projects, it would be the strongest annual growth rate since 1999, just before the late 1990s tech boom ended. Meanwhile, the 3.5% drop in GDP in 2020 was the largest annual decline since 1946.

Again, the CBO said the latest forecasts are stronger because the recession in the first half of 2020 was not as severe as previously reported, and the recovery which began in the second half was stronger than previously estimated. That’s all good news.

However, the CBO predicted growth will slow in 2022 to 2.4% and 2.3% in 2023, assuming there is no additional federal stimulus beyond this year. Keep in mind, of course, these longer-term forecasts are little more than educated guesses.

The CBO also updated its forecast for the unemployment rate in 2021. The CBO predicts the jobless rate will fall to 5.3% in 2021, down from 6.8% at the end of last year. That’s the good news; the bad news is the CBO believes it will be several more years (2025) before the millions of Americans who lost their jobs last year are fully back to work.

Finally, the CBO predicts US inflation, as measured by the Consumer Price Index, will rise to 1.9% this year, up from its previous estimate of 1.2%. It expects the CPI to continue to rise by 2.2% in 2022 and 2.3% in 2023.

CBO: Several Years To Get Economy Back To Full Potential

While the CBO’s forecast for the economy to return to a GDP growth rate of 4.6% by the end of this year was encouraging, it also cautioned that it will take several more years for the economy to rebound to its full potential, as if the pandemic had not occurred. Remember, there are still over 10 million Americans who lost jobs last year who remain unemployed.

What the CBO means regarding the economy returning to “full potential” is the point when all those people are employed again – hopefully in similar paying jobs. Specifically, the CBO said the economy is not likely to return to “maximum sustainable output” until 2025 – suggesting the burst of activity expected this year could be followed in the next several years by a long, slow recovery.

Furthermore, the CBO warned its latest projections were subject to “an unusually high degree of uncertainty” because of the pandemic, the impact of previous economic stimulus packages and the response by capital markets to the significantly increased US debt load.

In its summary overview of the latest forecasts, the CBO said it assumed we would get the COVID-19 pandemic under control at some point, thanks to continued increases in vaccinations and treatments. But the agency admits this assumption could be too optimistic, in which case it could take even longer to get the economy back to full potential.

Fed Will Tolerate A Post-Pandemic Inflation Spike

As noted earlier, most forecasters expect inflation to inch higher this year, not only because the economy is expected to strengthen and there is a lot of pent-up consumer demand, but also because most consumers are sitting on record amounts of cash which they saved during the pandemic.

Numerous forecasters believe consumers are sitting on at least $2 trillion more cash than they had prior to the pandemic. Some economists now believe there could be a spending spike as soon as consumers are confident the COVID-19 crisis is under control – which could drive prices considerably higher than most forecasters, including the CBO, currently predict.

The Fed has made it clear over the last few years it would like to see inflation rise to at least 2%. The question is: What would the Fed do if inflation were to spike well above 2% later this year or next? Fed Chairman Powell has actually addressed this question recently.

Fed policymakers have little doubt that costs for many goods and services will jump this year – which would be a bitter pill for consumers if gasoline, travel and other prices start to rebound from sharp declines last year. But, Fed officials argue, this would be part of getting back to normal, not the start of a more persistent inflation problem. Fed Chairman Powell said in late January:

“As people return to their normal lives... there could be quite exuberant spending and we could see upward pressure on prices. The real question is how large is that effect going to be and will it be persistent? A one-time increase in prices... is very unlikely to mean persistently high inflation.”

Keep in mind the Fed is committed to keeping short-term interest rates extremely low for the next few years. So what Chairman Powell is telegraphing to the financial markets is that the Fed would tolerate a rise in inflation to well above 2% because it believes such a spike would be short-lived.

Put differently, Mr. Powell is saying the Fed would not automatically hike interest rates if inflation rises well above 2%, because it believes such a move would be only temporary.

Above all, we need to understand this is a big gamble on the Fed’s part. History shows us that when inflation rises, it is not easy to keep under control. Such a situation may not occur in the next couple of years but as consumers and investors, we can’t rule it out.

Final Thought: Why Do We Need More Stimulus?

As discussed above, the Congressional Budget Office believes the US economy will continue to rebound strongly this year, with GDP growth of 4.6%, to be followed by several more years of expansion – without any more government stimulus.

This raises the question of whether the economy needs any additional federal stimulus. I would argue it does NOT. The CBO seems to agree.

Democrats and Republicans are in a heated battle over passing another stimulus package. President Biden and the Democrats continue to push hard for a huge $1.9 trillion stimulus deal, while Republicans counter with a plan totaling just over $600 billion. The two sides are currently at a stalemate, and it remains to be seen what will happen.

The Dems also continue to press on with their plan to raise the minimum wage to $15 per hour, even though a growing cohort of liberal economists agrees such a move is a bad idea.

My point is, the latest report from the Congressional Budget Office paints a very positive outlook for the US economy going forward, and the CBO made a clear point that its latest forecasts DO NOT include any additional federal stimulus spending.

My view is that the latest optimistic CBO forecasts will make it almost impossible for President Biden and the Democrats to get their $1.9 trillion stimulus package enacted. But that doesn’t mean they won’t try.

Lawmakers on both sides in Washington seem intent of passing another “feel good” stimulus package of some amount. I would guess they’ll compromise on something in the range of $1 trillion – whether we need it or not.

Wishing things were different,

Gary D. Halbert

SPECIAL ARTICLES

CBO: Economy Expected Back to Pre-pandemic Levels by Mid-Year

Fed Says It Will Tolerate Higher Inflation This Year & Next

Gary's Between the Lines Blog: IMF Hikes World Growth Forecast, Small Business Optimism Sinks

 

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