One year ago in this space, I wrote about the impact of Federal Reserve policy on the economy amid the COVID-19 pandemic. I argued that because of the stimulus packages being pumped into the economy, we would circumvent a recession similar to the Great Depression or Great Recession. One may reasonably argue that a depression has been avoided.
A man works inside a Morton’s Steakhouse restaurant in San Francisco on March 4. During both World War II and the COVID-19 pandemic, consumer spending sharply dropped and caused pent-up demand. Jeff Chiu/Associated Press, File
One year later it seems appropriate to ask a different question: What happens now? The short answer is simple: Nobody knows. We don’t know what the future holds for COVID-19 variants, vaccine distribution, pent-up demand, etc.
Let’s look at our economic past and see if answers could be gleaned.
Interestingly enough, today’s government spending and economic climate have striking similarities to World War II. The U.S. response to the war and the COVID-19 pandemic are comparable, in terms of economic forecasting, government spending, societal restrictions and consumer demand.
For starters, the onslaught of World War II brought forecasts of economic catastrophe. Paul Samuelson, a Nobel Prize-winning economist, said we must continue deficit spending after the war, or we would experience “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” Fast forward to August 2020. Time Magazine said, “Those expecting a so-called V-shaped economic recovery, a scenario in which vaccine makers conquer COVID-19 and everybody goes straight back to work, or even a smooth and steady longer-term bounce-back like the one that followed the global financial crisis a decade ago, are going to be disappointed.”
During the war, government spending ballooned to 45 percent of GDP, up from 11 percent just four years earlier. In 2020, government spending was 44 percent of GDP, up from 35 percent in 2019. In 1945, GDP dropped by 1.8 percent; in 2020, GDP dropped by 2.3 percent.
The war caused the government to ration consumer goods, including automobiles, gasoline and shoes. The COVID-19 pandemic led to a severe and immediate shock to the economy and Americans stayed home. In both time periods, consumer spending sharply dropped and caused pent-up demand.
After the war, troops came home and the economy roared to life. Postwar GDP increased nearly 50 percent from prewar GDP numbers. Homes were built, cars were produced in record numbers and the beginnings of the Cold War brought about a healthy dose of defense spending. The economy was (relatively) quick to pivot from wartime production to private production and the country saw tremendous growth throughout the 1950s.
The hope is that the 2020s will mimic the 1950s. I believe there will be significant growth.
Based on roughly $5.7 trillion in stimulus packages passed by the U.S. Congress since March 2020, including multiple direct-relief payments to families, the economy is in a position to grow. To highlight just how much money could be spent, let’s look at the personal savings rate, which is the percentage of someone’s income left over after expenses and typical spending.
The current personal savings rate is roughly double the five-year average. The rate averaged just over 7.5 percent over the last five years but jumped to 34 percent after the April 2020 stimulus and has plateaued around 14 percent since August 2020. With the American Rescue Plan, the rate is expected to increase even more. During times of real or expected economic growth, the personal savings rate typically drops as consumers spend more money because of confidence in a strengthening economy. This creates a self-fulfilling prophecy, as the reason for growth is confident consumer spending, which creates more demand.
What will happen later this year and beyond is, obviously, unknown even to the most seasoned economists, but history may provide an insight. Many economic differences exist between the 1940s-1950s and 2020-2021. Any cross-decade comparison fights the stigma of comparing apples and oranges. But with enough similarities between time periods, the postwar boom could provide hope for the post-COVID economy.
One uncertainty, with over $5 trillion in stimulus, is the impact on inflation. Theory would dictate that inflation will spike in the coming years, though that may be welcome.
Based on the actions of the Federal Reserve and Congress since March 2020, economic doom will most likely be avoided. The next question we may ask is: Did we do too much?
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