The pandemic’s effects on the economy are coming to an end

Labor market developments continue to show the economy outstripping the pessimistic expectations of monetary and fiscal authorities. It is well past time to reign in unnecessary monetary and fiscal expansion that are driving the economy into the wall created by artificially created constraints. 

In September and October, the unemployment rate declined to an unexpected 4.6 percent, from 5.2 percent in August and 4.8 percent in September, continuing its rapid descent from the pandemic/recession peak of 14.8 percent in April 2020. This decline recovers 90 percent of the 11.3 percentage-point rise in the unemployment rate in February to April 2020, and 99 percent of the rise above the estimated natural rate of unemployment of 4.5 percent at the time. 

Most economic analysts have consistently underestimated the pace of improvement of the economy since the bottom of the recession in April 2020. For example, in August 2020, a survey of members of the National Association of Business Economists found that only 7 percent expected that the economy would regain the peak Real Gross Domestic Product achieved at the end of 2019 by the second quarter of 2021, when it occurred. Most members with an opinion did not expect this to occur until at least a year later (spring 2022 or later).

Over time, forecasts improved but not as fast as the economy. Policymakers are no better. According to Peter Ireland and Mickey Levy with the Shadow Open Market Committee, the Federal Reserve’s Federal Open Market Committee (FOMC), its main policy-setting body, had a median projection of the unemployment rate for the end of 2020 of 7.6 percent in September 2020, only three months before the actual 6.7 percent was achieved. At the end of last year, the median unemployment rate projection for December of this year was 5.0 percent, 0.2 percentage points higher than the actual rate achieved in September. 

During this year, the FOMC has lowered this projection, to 4.8 percent as recently as September, but subsequent news has revealed it was already there. At the pace of decline in the unemployment rate in the first half of 2021, it will fall to 4.4 percent by the end of this year; if it follows the faster pace in June to September, it will reach 3.7 percent by then. If this happens, the economy arguably will have achieved full labor market equilibrium a year earlier than most analysts and policymakers publicly anticipate.

The Congressional Budget Office estimates the natural unemployment rate in 2021 is 4.5 percent — well within sight by the end of this year, if not this month. The FOMC projects the long-run unemployment rate, roughly the same as the natural rate, is 4 percent — also within the range of decline likely to happen over the rest of the year. Nonetheless, the Federal Reserve waited until Nov. 3 to announce a plan to eliminate the unnecessary and excessive inflationary stimulus adopted in February 2020.   

Some argue that the decline in employment is understated because it does not account for an expected rebound from a 1.7 percentage point decline in the labor force participation rate, the share of the population willing and able to work. It fell from a pre-pandemic 63.3 percent in February 2020 to an average 61.6 percent during the recovery and expansion from June 2020 to October 2021. The labor force participation rate has been remarkably stable through the past 18 months of recovery and expansion. This decline is not surprising; similar permanent declines in the participation rate occurred during and after the three previous recessions (in 1990-91, 2000-2001, and 2007-2010). 

The Federal Reserve Bank of Kansas City has pointed to unusually large increases in the retirement rate when the pandemic began. They suggest a small part of this could be reversed after the recession, but 18 months later this appears doubtful. Some of the decline could be because of the pandemic, but wide swings in the incidence of COVID-19 cases, hospitalizations and deaths, especially to low levels in June and July 2021, were not accompanied by rebounds in the labor force. The Federal Reserve Bank of Dallas also recently studied unusual retirements and they are more sanguine about the permanence of a 1 percent rise — equal to a 2.7 million decline in the labor force and employment — in the share of retirees in the population. 

It appears that retirements, especially early retirements, and increased disability claims or choosing to work at home and outside the labor force will fully account for the decline in labor force participation. Thus, employment will not return to the pre-pandemic 158.7 million workers for years, when the population grows enough to offset the decline in the participation rate.

A final piece of evidence for the ending of the pandemic’s economic effects is that the personal saving rate declined in September to 7.5 percent of disposable income — almost all the way to the pre-pandemic 7.3 percent in December 2019. Throughout the recession, recovery and expansion, the saving rate had been far higher, averaging 15.7 percent from February 2020 to August 2021. This new saving exceeded the pandemic-related government benefits added to personal income, in addition to the amount that would have been added to saving at its pre-pandemic pace.

In September, as pandemic-related payments came to an end, the decline in such benefits was $296.6 billion less than in August. Personal saving fell slightly more, by $329.0 billion, continuing a pattern of matching movements of personal saving and government transfer payments during the pandemic. Throughout the pandemic, as government payments to individuals spiked up, saving matched these amounts, resulting in historically unprecedented saving rates; as those programs ended, unusually high saving rates did as well.

Massive government transfer payments during the pandemic provided strong financial cushions to individuals, who added the money to their savings rather than following the government’s hoped for, and anticipated, boost to consumer spending. Instead, consumer spending grew rapidly along with private earnings, but did not include any spending that could be attributed to government benefits. The saving rate can be expected to track pre-pandemic behavior in the absence of other economic shocks, just as labor markets will.

John A. Tatom is a fellow at the Institute for Applied Economics, Global Health and the Study of Business Enterprise at Johns Hopkins University.