the economic outlook is extremely positive in the second half of 2021
Real GDP grew 6.5% annualized in the second quarter of 2021, below consensus expectations for growth of 8.4% annualized, and up from 6.3% (revised from 6.4% in the prior report) in the first quarter of 2021 and 4.5% (revised from 4.3%) in the fourth quarter of 2020. In year-over-year terms, real GDP grew 12.2 percent in the second quarter of 2021 after plunging 9.1% in the second quarter of 2020.
6.5% annualized growth doesn’t mean real GDP was actually 6.5% higher in the second quarter than the first. It means that if real GDP grew at the same annualized rate for four quarters, the economy would be 6.5% larger at the end of it.
Personal consumption expenditures grew 11.8% annualized in the second quarter, with spending on services up 12.0% annualized, the fastest growth of services spending since the pandemic struck-consumers are patronizing high-contact businesses again with fear of the pandemic receding. Gross private fixed investment grew a much softer 3.0% annualized in the second quarter, with a 7.0% annualized drop in nonresidential investment in structures and a 9.8% annualized drop in residential investment partially offsetting strong growth in investment in equipment, up 13.0% annualized, and intellectual property, up 10.7% annualized. Supply chain disruptions, surging prices for construction materials, and labor shortages were a drag on construction spending in the second quarter. Business inventories fell $169 billion (nominal) in the second quarter, subtracting 1.1% from annualized real GDP growth and providing more evidence of the disarray in business supply chains.
Some longer-term perspective is useful here. Real GDP plunged 10.1% (not annualized) from the fourth quarter of 2019 to the second quarter of 2020 as the pandemic shut down large swathes of the economy. After the most recent quarter’s increase, real GDP is now back above its pre-crisis peak. The economy has recovered much faster than after the 2008-2009 recession, when it took three and a half years for real GDP to reach its pre-crisis level. Both fiscal and monetary policy have been much more supportive of this recovery than the last one; policymakers learned from their mistakes. And crucially, the U.S. economy’s fundamentals were much stronger prior to this recession than in 2007. Consumer balance sheets were stronger, with less debt and higher savings, than prior to the ’08-’09 downturn. The combination of stronger economic fundamentals and more supportive economic policies means consumers have not been forced to tighten their belts on the one hand, and the government has not chosen to tighten its belt on the other. That has translated into a much faster recovery, with fewer personal bankruptcies, business failures, and other long-term pain in the private sector.
But the much faster recovery comes at a price. In addition to much higher fiscal deficits, inflation is much higher than the post-2009 recovery. The GDP price deflator-the average price of all goods and services produced in the U.S.-rose 6.0% annualized in the second quarter of 2021, the highest quarterly increase since 1981. The second quarter’s surge in inflation is a combination of very strong end demand and historic disarray in global supply chains. Inflation is most severe in pockets of the economy that are most affected by pandemic-related swings in demand and shortages-things like prices of new, used, and rental cars; airfares and other travel services; and construction materials in high demand due to the housing boom (again, pandemic-related due to the rise of remote work and schooling). Inflation should settle down in the back half of the year as supply chains normalize, displaced workers return to the labor market, and supply conditions improve. But risks to the inflation outlook are to the upside in the near term.
With the problems of supply chains and inflation noted, the economic outlook is extremely positive in the second half of 2021. With buoyant private demand and record job openings, hiring will be extremely strong as increased unemployment benefits end, fueling continued rapid growth of employment and real GDP. This buoyant outlook faces risks to the downside and also to the upside. To the downside, the delta variant, supply chain disruptions, inflation, and the possibility that displaced workers take longer than expected to re-enter the job market. To the upside, buoyant consumer demand, the vaccination drive is moving fast outside the United States, and displaced workers may find higher-paying jobs in higher productivity industries after the pandemic, fueling better long-run prospects for the economy.
At the Federal Reserve’s July decision yesterday, Chair Powell made clear that the Fed is likely to begin tapering its quantitative easing program in the next six months. PNC forecasts for the Fed’s next move to be a start to slowing its purchases of government-backed bonds (a.k.a. “taper quantitative easing”) in early 2022. With risks to growth roughly balanced, and risks to inflation to the upside, the Fed is more likely to start tapering a bit before early 2022 than after it.
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