Next month we will have all of the economic data for 2021. The final numbers will show growth was 5.5%, unemployment was down to 4% and inflation was 7.5%. What will happen in 2022?
Record Growth, But at What Cost?
Growth in 2021 was higher than at any time since 1984. Most of the growth was fueled by huge increases in government spending and extremely expansionary monetary policy. Households were given thousands of dollars in free money from the federal government. Much of that free money was saved, especially during lockdowns.
As lockdowns ended and the economy re-opened, consumers went on a spending spree, helping to create excess demand in the economy. Gross domestic product (GDP) reached the pre pandemic output level by July of 2021, and business attempted to grow even more, but they were constrained by a steep decline in available workers.
The combination of huge excess demand and somewhat constrained supply led to rising prices. That, coupled with policy-driven increases in energy prices, wage inflation caused by the labor shortage and vast increases in the money supply matched with near zero interest rates, created so much excess demand that inflation hit a 40-year high.
The economy did reach a full employment level partially, simply due to the 3.5 million workers who left the labor market during the pandemic and have not returned.
What will happen to the economy in 2022?
Economic growth should continue to be strong, but will be constrained by the continued labor shortage and the severity of Covid. Business, though, will get creative and substitute capital investments in automation or outsourcing for labor where possible. We see an example of that when we order from a touch screen at a fast food restaurant rather than ordering through an employee.
Reckless Government Spending to Continue
As long as the virus doesn’t become severe enough to cause shutdowns, the negative economic impact from the virus should not be severe. Growth will likely be in the 4.5% range.
Inflation will be a major problem, however. The federal government has deficit spent nearly $6 trillion dollars in the last two years. It continues to deficit spend about $200 billion monthly even today. That is pure excess demand and is the main driving force of the current inflation.
Households are full of free money that continues to be handed out by the federal government. As a result, consumers are demanding more goods and services, and they are willing to pay more for them. The Biden administration will certainly not reduce consumer spending. Rather, members of the administration want to spend trillions more.
The rest of the huge excess demand in the economy is a result of the extremely expansionary monetary policy. The Federal Reserve has increased the money supply by 20% in the last year while keeping interest rates near zero. That has caused massive excess demand, especially in markets that are interest-rate sensitive and use large amounts of debt financing. The housing market and the automobile market, for example, have seen huge price increases.
It Is Up to the Fed
How long this continues and how high inflation gets depends upon how quickly the Fed reverses course. Federal Reserve officials have started to slow the growth of the money supply by reducing their monthly bond buying. They say they will continue this until March. After that, they will consider raising interest rates.
Although the Fed’s timeline projections have had to be changed frequently because of their inaccuracy, let’s assume it sticks to that schedule. By June, the inflation rate could approach double digits. If that is the case, the Fed is bound to act more swiftly and more drastically.
That means instead of raising rates by one quarter percent three times next year, which is their current forecast, it will be forced to raise rates by a half percent or more and raise them more frequently.
If the inflation persists, the Fed will get yet more aggressive.
The danger is that if it gets too aggressive and take too much demand out of the economy, a recession could follow, as was the case in 1981. Back then, to stop the double-digit inflation, Fed Chair Paul Volker was forced to push interest rates to double-digit levels. A severe recession followed.
The most likely scenario for 2022 is that the Fed begins to raise interest rates in March and three more times before year-end, mostly by a quarter of a point each time, meaning rates will be at one to one and a half percent higher than they are today.
Assuming no additional government spending is passed, 2022 should see 4.5% growth, less than 4% unemployment, with inflation topping 8%.
Michael Busler is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in finance and economics. He has written op-ed columns in major newspapers for more than 35 years.
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