Last Friday’s U.S. retail sales numbers provided comfort for both the V and the square-root economic recovery camps. But rather than mark the beginning of a consensus on what lies ahead, they highlight a durable debate raging not just on Wall Street, but also on Capitol Hill.
By adding 1.2% growth after the 8.4% rebound of the previous month, the overall level of retail sales has fully recovered from the sharp March-April decline and completed an impressive V-shaped recovery.
With consumption accounting for almost 70% of gross domestic product, many on Wall Street now hope that investment will soon pick up strongly to solidify such a comeback for economic activity as a whole.
Others see the data consistent with a less optimistic outlook for the U.S. economy. Noting the fall in the rate of improvement (the so-called second derivative), they worry that the best of the recovery may already be behind us. Some of the highest frequency indicators, as partial as they are, already point to a leveling off in activity.
The risk is that coming economic reports will fail to resolve these diverging views that pit the first and second derivatives in data series against each other. Yet the longer this difference persists, the greater the chance that the economy may not just level off, but contract. To understand why and how, you need to look at the way the debate plays out in Washington.
Republican lawmakers see the more optimistic interpretation as anchoring their resolve to hold off on the type of substantial relief bill that Democrats have been advocating. Some within the party go further, arguing that such legislation would undermine durable growth in three ways.
First, by tilting incentives in favor of unemployment for those who earn more with enhanced supplementary unemployment benefits than they would at work. Next, by keeping inefficient companies alive, distorting resource allocations and eroding productivity growth. Last, by encouraging inefficient interventions in economic activity by local and state governments.
Democratic lawmakers take an opposite view, supported by the less optimistic take on the same data. For them, the slowing recovery risks turning temporary and reversible problems into longer-term ones that are more deeply embedded in the structure of the economy, and therefore more damaging and harder to solve. They see a strong case for action on measures that not only continue the exceptional support for those out of work and for companies risking closure, but also to backstop local and state governments that are large employers on their own account.
Unlike Congress, systemically important central banks led by the Federal Reserve and European Central Bank have repeatedly expressed a clear, consistent view in such situations for over a decade. Indeed, they have gone well beyond anything that would likely be envisaged on Capitol Hill, adopting and sticking to what is known as an “insurance mindset.”
Rather than get bogged down in debating two competing hypotheses that data are unlikely to resolve any time soon, lawmakers should consider the risks associated with ending up being wrong. In this highly uncertain world of COVID-19, an insurance-style approach of “regret minimization” would argue that it’s easier to undo what would, with hindsight, be deemed a mistake of doing too much, rather than too little. In short, opt on the side of a bigger relief bill as soon as possible.
Congress shouldn’t go all the way in following an approach that has inadvertently landed central banks in a lose-lose situation after years of doing more of the same. But avoiding the banks’ “no exit” dilemma shouldn’t stop lawmakers in going some way to adopting a mindset of regret minimization. It’s the only way to ensure that their own stalemate doesn’t end up imposing an outcome that neither party wants – a renewed economic contraction.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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