Midway through 2022, the latest variants of COVID-19 are leading to a global surge of cases, a reminder that the pandemic still isn’t over.
Meanwhile, it’s clear that efforts to fight the pandemic have created major problems for the economy. Shutdowns during the early stages of the pandemic, followed by a huge increase of demand when the economy later reopened, threw supply chains out of whack, and they have been slow to ramp back up. Stimulus packages to prop up the economy during the pandemic, including $900 billion approved by President Donald Trump in December of 2020 and a $1.9 trillion package approved by President Joe Biden in March of 2021, plus similar stimulus programs done by other countries, have driven a major increase in inflation.
In June, the Consumer Price Index rose 9.1% year-over-year, the highest rate of inflation in the U.S. since November of 1981.
Consumers have been particularly stung by rising gas prices. Gas prices in the Milwaukee area in mid-July averaged $4.51 per gallon, up from $2.99 a year ago, according to AAA.
Plus, wages haven’t kept up with inflation. Inflation-adjusted earnings are down 3.6% from a year ago, according to the Bureau of Labor Statistics.
The Federal Reserve has promised to be aggressive in fighting inflation. In June, the Fed raised interest rates by 0.75 percent and more increases are expected as long as inflation remains high.
The rising interest rates should cool the economy down. Some fear too much. The stock market has suffered significant losses this year with the Dow Jones Industrial Average down 16%, the Nasdaq index down 29% and the S&P 500 down 21% year-to-date.
U.S. GDP grew 5.7% in 2021 after decreasing 3.4% in 2020. But in the first quarter of 2022, U.S. GDP fell 1.6% and the Federal Reserve Bank of Atlanta’s GDPNow forecasting model projects that second quarter GDP fell 1.6%. Many consider two consecutive quarters of declining GDP a recession, although the National Bureau of Economic Research takes a more nuanced approach that accounts for the depth, spread and duration of a decline in economic activity.
But perhaps the strong labor market will be the economy’s saving grace and might soften any recession. Employment rose 372,000 in June in the U.S. and the nation’s unemployment rate remains at a low 3.6%. Wisconsin’s unemployment rate was even lower at 2.9% in June.
Indeed, many employers are struggling to fill open positions. The U.S. labor force participation rate of 62.2% is still below the pre-pandemic level 63.4% in February of 2020. More labor force participation would help employers fill their open positions.
With concerns abounding about inflation and so many signs pointing toward recession, BizTimes Milwaukee once again turns to economist Michael Knetter for insight on the macro economy. A regular speaker at the annual BizTimes Media Economic Trends Event, Knetter is the president and chief executive officer of the University of Wisconsin Foundation. Earlier in his career, he served as a White House economic advisor for the George H.W. Bush and Bill Clinton administrations.
BizTimes Milwaukee editor Andrew Weiland recently interviewed Knetter to get his thoughts on the 2022 economy at the mid-year point. Following are the questions and responses.
BizTimes: Inflation is occurring at levels not seen in decades and it’s obviously a major concern for consumers and businesses. How much longer do you think we are going to have elevated levels of inflation?
Knetter: “If elevated is above 2% - 2.5% core inflation, I expect it to be elevated for a few years but to come down substantially from current levels. The 5-year TIPS (Treasury Inflation-Protected Securities) breakeven rate for inflation is about 2.75%. That is the market’s guess at the average over that period, and I would have no reason to think my instincts are better than that. To reach that average, we would need inflation to come back to something like 4% by year end.”
BizTimes: The Fed is fighting back against inflation, including its recent 0.75-point interest rate increase. Is that too little, too much or just right? What impact will it have? What do you anticipate from the Fed for the rest of the year?
Knetter: “I think they moved a bit late, but so far, they have been about right. They have cooled demand for mortgages and credit broadly and asset price declines will curb spending in ways that will offset the excess demand created by pandemic stimulus. I don’t think the Fed should go much further now. I continue to believe most of our inflation problem is due to adverse supply shocks associated with the pandemic. Interest rate hikes don’t fix that and arguably reduce incentives for supply to recover.”
BizTimes: One of the biggest price concerns for consumers is gas. Are we going to get any relief at the pump, or do you think gas prices will continue to rise, and if so, how high?
Knetter: “I think gas prices will be largely stable from current levels unless we reduce gas taxes.”
BizTimes: Are we headed for a recession or already in one? If so, how long will it last?
Knetter: “I don’t think we are in one at present, but demand is slowing considerably. That’s why I think the Fed will lighten up on rate hikes and hopefully the economy continues to grow at moderate rates as supply recovers. It is a delicate balance to strike.”
BizTimes: The labor market remains very healthy with an extremely low unemployment rate. Do you expect that to continue? Will the strong labor market keep us out of a recession or reduce the severity of a recession?
Knetter: “Low unemployment and rising wages are two big reasons we might avoid a recession.”
BizTimes: “What impact is the tight labor market and inflation having on wages?”
Knetter: “Wage growth is healthy, although not completely keeping up with short term inflation. That is to be expected. Fiscal and monetary policy pushed demand beyond our supply capacity. We are paying for that with some inflation now.”
BizTimes: Do you see any improvement with supply chains? It seems like we are still having some significant problems with some products, especially baby formula.
Knetter: “Supply chains will slowly improve as pandemic concerns abate and we adjust to the disruption caused by Putin’s invasion of Ukraine.”
BizTimes: The stock market has lost a tremendous amount of value this year. Does that indicate a rough economy for the coming months? Do you anticipate a market rebound in the second half of the year or more pain on Wall Street?
Knetter: “The stock market fell sharply in the first half of this year, but people forget that the S&P index was at about 3,300 before the pandemic hit in 2020. So, we sit here today (with the S&P 500 at 3,800 at press time) about 15% above where the market was pre-pandemic. That’s hardly a disaster. In fact, it is close to long-run average growth of the index.”
BizTimes: Does the crypto crash mean it will become a passing fad, or will cryptocurrency rebound as the wave of the future?
Knetter: “Crypto in my opinion remains an asset class rooted in blind faith or the greater fool theory. It is not very useful for payments relative to other options unless you are a criminal. As an asset it has no earnings. It has a following, and it may hang around and maybe gain traction, but that’s not my expectation.”
BizTimes: The red-hot housing market has shown some signs of cooling recently. How do you think the housing market will fare in the coming months?
Knetter: “It will level out due to higher interest rates and improving supply chains.”
BizTimes: With so many people still working from home, is the office real estate market facing a significant decline?
Knetter: “It’s hard to say. Only a small fraction of people will work fully remote. The biggest impact will be in markets dominated by the tech sector, which will embrace remote.”
BizTimes: What impact has Russia’s invasion of Ukraine had on the economy, and is that going to remain a significant headwind?
Knetter: “It’s significant as an increase to the negative COVID supply (chain) shock. It could topple Europe into recession. That might have some ripple effect and cause big divergence in currency values (resulting in a much stronger dollar).”
