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The U.S. and global economies have been under severe stress since the beginning of the COVID-19 pandemic in March of 2020. The pandemic has caused shifts in the economy, some likely temporary, but others could be permanent.
Nearly two years since it began, the pandemic rages on with the highly contagious but less severe omicron variant. Hospitals in Wisconsin have been overwhelmed with COVID-19 patients since the delta variant’s significant spread throughout the U.S. in the second half of 2021.
The presence of an extremely transmissive but more benign variant will hopefully bring an end to the COVID-19 pandemic, perhaps establishing it an endemic (something we simply live with).
In 2021 there was hope that the availability of COVID-19 vaccines would be the thing to bring the pandemic to an end. COVID-19 cases dropped significantly in the middle of the year, but then there was a resurgence of the virus as it spread, mostly among unvaccinated individuals.
As COVID-19 cases waned, U.S. GDP rose 6.7% in the second quarter of 2021. But as the pandemic flared up again, U.S. GDP only grew 2.3% in the third quarter.
Inflation has been a major headwind for the economy. Government stimulus during the pandemic, in the U.S. but in other nations has well, has likely contributed to inflation. But the pandemic also caused a shift in consumer habits away from social experiences in favor of consumer goods, and the supply chain has struggled to keep up, which has also led to higher prices.
The Consumer Price Index rose 7% from December of 2020 to December of 2021, the largest 12-month increase since 1982. Energy prices rose 29.3% over the last year, and food prices increased 6.3%, according to the U.S. Bureau of Labor Statistics.
Another challenge for the economy is the extremely tight labor market, which has also been exacerbated by the pandemic as some workers left the labor force and have not returned. The U.S. unemployment rate was 3.9% in December, and Wisconsin’s is even lower at 3.0%. That’s good news for workers, of course, but many businesses are struggling to fill open positions, which is hurting their ability to grow. U.S. job growth has been tepid.
The tight labor market and inflation are contributing to higher wages – again, good for workers but a challenge for businesses.
Despite the challenges, there are indications the economy is gaining steam. The GDPNow indicator from the Federal Reserve Bank of Atlanta projects 5% GDP growth in the fourth quarter of 2021.
So, where are we headed in 2022? Will the pandemic finally come to an end? Is inflation going to derail an economic recovery? Will people working at home return to the office? Have the economic shifts of the pandemic created a great reallocation and therefore a new normal?
To answer these questions and more, we once again turn to Michael Knetter, an economist and the president and chief executive officer of the University of Wisconsin Foundation. Knetter served as a White House economic advisor for the George H.W. Bush and Bill Clinton administrations, and each year he provides a macro economic outlook at BizTimes Media’s annual Economic Trends Event (to be held on Jan. 27).
BizTimes Milwaukee editor Andrew Weiland recently conducted his annual economic outlook Q&A with Knetter. Following are those questions and his responses.
BizTimes: What is your take on the overall economy? The pandemic – and attempts to fight it – has shaken up so many things, including the labor force, the supply chain, inflation and commercial real estate. Where are we headed in 2022?
Knetter: “There is still significant capacity for growth. Unemployment rates are low, but that is partly due to weak labor force participation. I think that will resolve by fall. People will need to work to maintain balance sheets, and the pandemic will have subsided enough to become an endemic, and we will see a next normal assert itself.”
BizTimes: In an earlier conversation, you used the term ‘great reallocation’ to describe what you see happening in the economy. What did you mean by that?
Knetter: “It is a refinement or extension of the ‘great resignation,’ a term used to suggest a mass exodus of workers from existing jobs. The great resignation is a real thing, but only part of the story. The pandemic caused a disruption in labor supply and consumer demand that is unprecedented. The closest analogy might be the forced changes to labor, production and consumption that accompany a wartime economy. As the pandemic abates (and I think we will see that in 2022), we will see another great reallocation of labor and spending from a pandemic-constrained outcome to a new normal.
“The new normal will look much like the old normal except there will be more opportunity for remote work (I would guess 25% of total hours worked will be remote versus 5% pre-pandemic, with big variations by industry, per research done by Stanford economist Nicholas Bloom) and less business travel (which will hurt hospitality and airlines). Both of these shifts will be good for productivity and quality of life.
“Some of the decline in labor force participation is forever lost as people retired early, but that is a temporary loss as they would have retired eventually anyway. Most of the decline will be reversed once we are confident schools will stay open and dual-earner families can return to normal.
“Labor will gain slightly relative to capital in the split of the economic pie. Remote work options do eliminate some of the frictions in the labor market that favored capital, which was always more mobile than labor and especially so in a globalizing economy.
“By the end of 2022, I am predicting we will be in our new normal.”
BizTimes: The supply chain mess has been felt throughout the economy. What’s going on there? Do you think that will work itself out in 2022, or is this a long-term systemic problem?
Knetter: “The supply chain disruptions resulted mainly from two things: pandemic disruptions to the workforce in key input sectors and transportation (shipping) and large shifts in consumer demand away from things like leisure and hospitality into hard goods. Both labor supply and consumer demand shifts caused shortages throughout the economy. These will get worked out in 2022.”
BizTimes: Inflation is a significant issue, as the CPI is rising at the fastest pace since 1982. What do you expect to happen with inflation in 2022?
Knetter: “Inflation starts the year high, around 6% and then subsides to more like 4% at year end with further deceleration in 2023 as the new normal sets in. By 2024, we will see inflation back between 2-3%.”
BizTimes: Why hasn’t the Fed taken action yet to tamp down inflation? What do you expect them to do in 2022?
Knetter: “I think the Fed wanted to be sure we were past the worst pandemic shocks before tackling inflation. It seems they feel we are finally there. They are banking on everyone understanding that some inflationary pressures are truly temporary and can be reversed. The market expects three 25 basis point hikes in 2022, and I think we will get them.”
BizTimes: With so many people working from home, shopping online and ordering carry-out, the pandemic has shaken up the commercial real estate market, especially for office space. Do you think work from home is with us permanently? Is the 9-to-5, seven-days-a-week work schedule in the office a thing of the past?
Knetter: “Nicholas Bloom has a trove of data and analysis on this subject. I predict that 25% of hours worked will be done remotely in the new normal, a five-fold increase relative to 2019. The impact on office space will be negative and very uneven. Where you have high concentration of industry where remote work is a viable option, we will see larger disruptions. I would think of Manhattan as a leading example.”
BizTimes: What do you expect from the stock market in 2022?
Knetter: “A surprise, but I am not sure what kind! I think it is a year fraught with risks of all sorts … policy risks, geopolitical risks and more. I’m going to forecast a flat stock market but that is the average of two very different worlds. If policymakers navigate the transition to lower inflation smoothly, there is room for equities to march higher. But there is a risk of a mistake or a geopolitical event that could provoke a shift to a risk off environment and a correction.”
BizTimes: How will U.S. GDP fare in 2022?
Knetter: “I expect real GDP growth to be around 3.7%, which is above long-term trend and reflects growing labor force participation as the pandemic resolves.”
BizTimes: Any final thoughts?
Knetter: “We have gone through a two-year period unlike anything most of us will ever experience (or so we hope). The entire world was upended by a virus that was especially lethal for older and immunocompromised people. The global pandemic will have long-term implications that are yet to be seen. The following significant changes can be attributed, at least in part, to the pandemic:
Dramatic increases in sovereign government indebtedness and central bank balance sheets.
A reversal of the global integration of the economy that had been ongoing since the 1970s (most notably the inward shift of China).
A change in the executive branch of government (I am conjecturing Trump would have been re-elected but for his attitude toward the pandemic).
A revolution in remote-work options.
A shift away from travel and events toward more home-based activities and spending, reducing the variety of our experiences but maybe increasing our sense of intentionality about what we do and who we do it with.
Increased polarization in viewpoints and skepticism of traditional government, media or science authorities (or conventional wisdom).
“The global pandemic brought most people closer to small circles of relationships but has almost certainly caused greater detachment from everything outside of our small circles except that which is available on the internet. This is also true for countries. That is a bit ironic, since one might have imagined a global pandemic would bring nations into deeper collaboration. Instead, it has been more of a competition to acquire the resources to fight the pandemic internally or even locally.
“I believe that the pandemic has made our world more insular and divided. My hope that the pandemic would restore some faith and trust in science proved optimistic. The scientific path toward understanding new phenomena with a high degree of confidence is often slow and winding. The voices of thoughtful scientists were too often overwhelmed by media and political voices with divisive agendas that serve their own interests. Entertainment masquerading as news is just too seductive for most consumers, and so the voices of moderate thoughtful scientists are not able to get much of an audience.
“Solving challenging problems in the public space at the state or national level has gotten more difficult because of polarization and distrust that seem to have grown during the pandemic. And unfortunately, federal indebtedness and central bank balance sheet expansion may put a premium on national economic policy management. Can our two-party system find a way to come together to address pressing national problems when we are already overextended in our fiscal and monetary policies? Unlikely. If one party had control, would we like the actions they might take? I wish I felt more confident about that.
“Solving global problems, like the pandemic itself or pollution and climate change, has likely also gotten more difficult due to the inward turn of most nations. And global problems are growing. Western democracies certainly need to pull closer together and take global leadership before China does.
“On the plus side, the private sector has shown an amazing ability to adapt and solve complex new problems quickly and effectively. That was never more evident than in the first three months of pandemic lockdowns. Markets were disrupted but new solutions filled the void remarkably quickly, aided of course by massive fiscal and monetary stimulus. The work-from-home revolution that was born of necessity will deliver a long-term environmental and productivity dividend.
“The gulf between the effectiveness of the public sector and private sector is large and growing. The only way that is a healthy thing for the country is if the private sector can begin to help tackle the challenges that the public sector traditionally addressed. Whether the private sector can organize at the scale needed to address national and global challenges remains to be seen. The vaccine development and recent space travel forays suggest that private sector actors are showing more interest in these grand challenges. How can we shift the incentives of private actors to engage them in the new challenges we face? If elected officials cannot fix our major problems, maybe they can figure out how to outsource them to people who can.”