Federal Reserve Bank of Chicago Economic Forecast: U.S. Recovery Path After COVID-19
A FRAMEWORK FOR THINKING ABOUT THE IMPACT OF COVID-19 ON THE ECONOMY • What we thought the US economy would look like in 2020 in January • Broad consensus that 2020 would see US economic growth slightly above trend but slowing from the levels of 2018 and 2019. GDP growth of 2.0% to 2.2%. • Why continued growth? Consumer was the key. Tight labor markets and low interest rates would encourage spending and drive the economy. Some also felt that trade frictions would lessen and this might lead to business expansion and increases in business investment. • Few identified large risks to economic growth. A very sanguine outlook.
SO WHAT HAPPENED • COVID in some ways is a black swan event. • Trying to understand how the economy will respond and recover is an uncertain exercise. Why? • This isn’t like any other recession. Can’t use the Great Recession or even the Great Depression as a playbook for predicting recovery. • You also can’t use a natural disaster as a template. While a hurricane shuts down economic activity, its duration is known. • The impacts of the crisis are felt unevenly. Exposure to the economic fallout differs based on industry mix and for governments what types of revenue you rely on. • Pick your favorite forecast…
FIRST OFFICIAL U.S. GDP ESTIMATE FOR Q1—(-4.8%)
CURRENT FORECASTS ARE CRYSTAL CLEAR—PICK YOUR FAVORITE Annual Rate % Change in US GDP—9 private forecasts Q1 2020 Q2 2020 Q3 2020 Q4 2020 Median -3.6 -34.0 19.7 10.0 projection Best -2.2 -24.5 35.0 15.7 projection Worst -10.0 -45.0 -0.4 3.2 projection
A FUNDAMENTAL QUESTION • Is this a liquidity event or a solvency event? • For some, (those who entered the period with reserves and less economically sensitive revenues) it’s a cash flow/liquidity issue. • For others, its both. More than just regaining the revenues that were lost during the period. This may expose them to having to radically alter their business to stay in business. • This is all predicated on some idea of how consumers will act when we return to a “new” normal.
TIME FOR BEHAVIORAL ECONOMICS? • Lessons from the Great Recession—people didn’t do what economic models wanted them to do. • Theory would have suggested that with super-low interest rates and ARRA federal stimulus that consumers would not only spend, but would take on debt. Same for firms. • However, behavioral economist saw a shift in consumer thinking. The future was uncertain and the appetite for risk was diminished. People and firms deleveraged and increased savings. • Having reserves was more valued than pushing the limits on growth through leverage.
WHAT WILL HAPPEN THIS TIME • Starting point—a good time for humility. The best you can do is create scenarios. • Examples—Best case. An effective vaccine or herd immunity becomes available quickly. The risk of COVID infection drops to near zero, people have confidence that they can go back to a pre-COVID lifestyle. Maybe a V shaped recovery. • Intermediate case. A vaccine is still in development but an effective treatment protocol is available and minimizes the death toll and impact on the healthcare system. Social contact is less risky but some measures remain in place to limit spread. Some recovery of economic activity. • The least good case—No vaccine and effective treatment protocol is developed, inability to contact trace makes social distancing the only effective tool against spread, efforts to restart the economy are met with second wave infections—Spanish Flu. (28% of population infected, deaths between 500,000 and 800,000 in the US, with higher concentration in the second wave)
GETTING MORE SPECIFIC—WHERE HAS THE IMPACT BEEN MOST NOTICEABLE • Labor market—unemployment claims • Financial markets—volatility, fund outflows • Governments—revenue declines and spending spikes • Consumers—hunkering down and savings • Most exposed industries
UNEMPLOYMENT CLAIMS—NEVER SEEN THIS BEFORE (AND THIS IS SMOOTHED)
FINANCIAL VOLATILITY SPIKE WAS UNPRECEDENTED— ( EVEN IN THE GREAT RECESSION IT NEVER WENT ABOVE 50)
STOCK RECOVERY HAS BEEN A BIT OF A SURPRISE
WHAT WILL DRIVE THE BAD GDP FIGURES—CONSUMERS STOP BUYING
APRIL RETAIL SALES WERE TERRIBLE
WHAT IS THE RESPONSE WHEN YOU STOP BUYING STUFF AND FACE AN UNCERTAIN FUTURE—SAVE MONEY
GETTING SPECIFIC—WHICH INDUSTRIES AND PLACES ARE MOST EXPOSED
MORE ON INDUSTRY IMPACT • First wave of impacts were felt by customer facing service businesses— anything non-essential retail. • As shutdown wore on secondary impacts started showing up in manufacturing. Customer demand fell as the timing of the recovery became more uncertain. • Supply chains showed strain. International supply chains became frayed. Domestic supply chains fared better but still were impacted—distinction between essential and non-essential operations. • Decisions about supply chains will be an important consideration post pandemic.
METRO IMPACT BASED ON INDUSTRY COMPOSITION
MAP OF METROS HIT THE HARDEST
Exposure of Seventh District Cities MIDWEST METRO EXPOSURE City Exposure rank out of Share of General Fund Share of metro Fiscal impact 140 revenues from elastic employment in high risk classification sources (2019) industries* (2019) Grand Rapids 10 62.19 18.3 More immediate Indianapolis 28 38.03 18.0 More immediate Detroit 34 30.04 15.4 More immediate Dearborn 75 7.95 15.4 Mid-term Chicago 81 1.81 18.2 Mid-term Warren 103 0.0 15.4 Mid-term Milwaukee 105 0.0 15.3 Mid-term Ft. Wayne 107 0.0 15.1 Mid-term Cedar Rapids 108 0.0 15.1 Mid-term
WHAT HAS THE GOVERNMENT DONE? • Answer—a lot • CARES Act--$2 trillion—Michigan’s share was $3.9 billion ($800 million to local governments over 500,000 population/$900 million to high impact hospitals) • Second installment--$1.2 trillion • The Federal Reserve--$2.3 trillion in lending support • Cut Fed Funds rate to 0% to 0.25% and commitment to maintain • Created new facilities—Main Street Lending Program (small and mid-sized business) and Municipal Liquidity Fund ($500 billion to state and local government)
MICHIGAN HAS RECEIVED $16 BILLION IN PPP
MOODY’S ANALYTICS FISCAL STRESS ESTIMATES . Estimates of fiscal shock under BASELINE scenario % tax revenue $ value of tax Estimated % $ value of % of combined $ value of shortfall revenue increase in Medicaid fiscal shock combined fiscal shortfall Medicaid spending shock (% of General spending (% of increase Fund spending) general fund spending) All states -14.8 130.4 (b) 3.1 27.4 (b) -17.9 157.8 (b) Illinois -13.1 5.1 (b) 2.7 1.06 (b) -15.9 6.2(b) Indiana -16.0 2.66 (b) 3.1 516 (m) -19.1 3.2 (b) Iowa -11.4 898 (m) 2.6 205 (m) -14.0 1.1(b) Michigan -18.6 1.9 (b) 8.4 872 (m) -27.0 2.8 (b) Wisconsin -9.9 1.7 (b) 3.6 627 (m) -13.5 2.3 (b) Baseline Scenario - Moderate Stress » Deep recession in first half of 2020 followed by modest rebound. Travel and business restrictions in effect through late second quarter. » Peak jobless rate of 13% in 2020Q2. Peak-to-trough real GDP decline of 10%.
DID STATES HAVE A CUSHION HEADED INTO THE CRISIS? Total Reserves/Estimated Shortfall (ability of the state to cover fiscal shock through savings) Reserves/Revenue shock— Reserves/Revenue shock- baseline scenario severe scenario (1) (estimated budget gap-% of (estimated budget gap-% of spending) spending) All States -3.2 -8.3 Illinois -14.7 -19.5 Indiana -5.5 -12.7 Iowa -0.6 -4.1 Michigan -9.7 -16.4 Wisconsin -3.5 -7.0 (1) Severe Stress » Travel and business restrictions last into the third quarter, delaying recovery and causing more long-term disruptions. » Peak jobless rate of 17%. Peak-to trough real GDP decline of 14%.
ESTIMATES OF REVENUE DECLINE IN MICHIGAN • Current fiscal year, -$1.98 billion General Fund, -1.25 billion School Aid Fund • FY20-21, -$1.92 billion General Fund, -1.14 billion School Aid Fund
THE GOOD NEWS--MICHIGAN FLATTENING THE CURVE
OTHER THINGS TO PONDER—ADJUSTMENTS TO FUTURE ECONOMIC ACTIVITY • McKinsey—The Resilience Economy • What happens to cities—density is a bad thing? • Is telework a new reality—impact on transit • Open floor plans—shared office space, maybe not • Spending on health screening devices—not just metal detectors
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