Conventional forecasting models have been more off the mark than usual in this post-pandemic recovery. But why? Perhaps the most overlooked explanation for American resilience is that, far more than other countries, developed and developing, US kept stimulating its economy well after the recession of 2020 was over.
Trump and Biden, both bountiful | Some of that fiscal and monetary stimulus is still coursing through the system, keeping growth artificially high, and making inflation for both consumer and asset prices significantly more persistent in US than in its peers.
After the pandemic struck, presidents Trump and Biden unleashed around $10trn in new spending, $8trn of that after the brief, lockdown-induced recession of early 2020 was over. US govt spending has been running at a yearly level around $2trn higher than its pre-pandemic norm, and is on course to set records as a share of GDP.
Meanwhile, the rest of the developed world has been heading in a different direction. In the years since the start of the pandemic, rising deficits amounted to a cumulative 40% of GDP in US, twice the average in Europe, and a third higher than in UK.
By some estimates, fiscal stimulus accounted for more than a third of US growth in 2023; without it, US would not look like such a marvel compared to other developed economies — and to developing economies as well.
India’s fiscal stimulus, more calibrated | GOI raised spending during the pandemic to address some of the health needs created by the virus, and to help businesses through a hard lockdown — but not beyond. By the end of 2023, US deficit was up by 4% of GDP over pre-pandemic levels, or about three times the increase in developing countries including India.
One result is that India’s public debt is up by about 8 points as a share of GDP — half the increase in US. Another is that, while swings in inflation have barely widened in large emerging economies including India, they have grown roughly fivefold in US.
Even more under-appreciated than the boost from runaway govt spending is the way monetary growth has been supercharging the economy and the financial markets. The Fed created so much money during the pandemic that by some measures the excess has still not been fully absorbed by the economy.
Liquidity hangover | The broad measure of money supply known as M2, which includes cash held in money market accounts and bank deposits, as well as other forms of savings, is still well above its pre-pandemic trend. In Europe and UK, where monetary stimulus was less aggressive, M2 has fallen back below trend.
This liquidity hangover has countered Fed interest rate hikes and helps explain the current behaviour of asset prices. Corporate earnings are up, on strong GDP growth, but prices for stocks — not to mention Bitcoin, gold and much else — have been rising even faster. This odd combination — higher stock valuations despite higher rates — has not happened in any period of Fed rate hikes going back to the late 1950s.
Housing party | A similar levitation act is visible in the US housing market; despite higher mortgage rates, prices have risen steadily, and faster than in other developed nations. Since 2020, total net worth of US households has risen by nearly $40trn to $157trn, driven by home and stock prices.
For the better off, this “wealth effect” is a happy turn. A recent poll showed that more Americans plan to vacation abroad this summer than at any time since records began in the 1960s. For the less well off, who summer closer to home, do not own a home and tend to be younger, these conditions are less felicitous.
There are of course other reasonable explanations for US resilience, including the surge in immigration and the AI boom. Moreover, many American debtors are paying fixed rates and won’t get hit by hikes until they need to refinance their loans. New govt incentives are drawing billions in investment to subsidised industries, from green tech to computer chips.
Heat is on, who’s melting? | But this much seems clear: with both consumer prices and asset prices more elevated in US than its peers, the economy is overheated and the Fed has less room to cut rates than expected. As long as interest rates remain higher for longer, US will be asking for worse trouble if it keeps running deficits close to 6% of GDP; that is twice the pre-pandemic average for US, and six times the median for western Europe. US cannot sustain such aggressive stimulus indefinitely, and govt spending is already slowing.
Economics though is far from an exact science, and it is hard to know when exactly the sugar rush from the past stimulus will wear off. But once it does, the landing may come faster than any conventional model suggests now.
The writer is an author and global investor.