Keepin' Busy

The Federal Reserve has been staying busy, as one would expect from the country's most important policymaking institution in the middle of an economic crisis. While the scope for moving the federal funds rate is low to non-existent (it hovers just above zero), quantitative easing remains a focus.  As an earlier post detailed, the Fed has extended their reach into longer-term Treasury securities, municipal bonds, mortgage backed securities, and commercial paper.  Also, for the first time in its history, the Fed bought corporate bonds. Till recently they were buying exchange-traded funds that track the corporate bond market. This week, however, the Fed announced they will be buying individual coporate bond issuances on the primary market as part of their efforts "to support market functioning and ease credit conditions."

The Federal Open Market Committee met earlier in June.  Usually, the fate of the federal funds rate is the most important agenda item, but with not much to do on that front, the discussion of the economy's future was the key bullet point on their list.  Every quarter the Fed releases an official economic "outlook." However, the March's release was postponed because, at that point, with the shutdowns just starting, the uncertainty was overwhelming, and even the Fed had little idea of what to expect!  So the "Summary of Economic Projections" was released with the June meeting minues.  

“The ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term”

The policymakers see continued levels of further contraction, high unemployment, low inflation and rock-bottom interested rates through this year, with glimmers of hope in 2021.  The interesting thing about the Fed's projection is the high levels of uncertainty. The "Summary" is actually a compilation of projections from the seventeen FOMC members.  As this table below shows, while the average prediction for GDP is 5% growth in 2021, but the range is anywhere from -1% to 7%.  

Summary of Economic Projections 

Some members of the Fed also had thoughts on another prevailing issue of the day: systemic racism.  Minneapolis Fed President Kashkari, Dallas Fed President Kaplan, Atlanta Fed President Bostic and Chairman Powell have commented on the deleterious affects of systemic racism on the American economy.

"The Fed’s response to the pandemic and its aggressive pursuit of its goals of stable inflation and full employment, Bostic said, is one way it can contribute to ending racism, by laying the groundwork for businesses to grow faster, hire more workers, and create “opportunities for African Americans and others who have not been as attached to the economy.” (Raphael Bostic, CEO and President of the Atlanta Fed)

Where It Hurts...

At first, it seemed there was not much to be said about prices...

The BLS released Consumer Price Index (CPI) data and to no one's surprise (unlike the unemployment data last week!), the CPI reflected what usually happens in a recession- it went down .1% in May, the third straight week.  In April, the decline was .8%, the largest one since the Great Recession in 2008.  Also, not surprisingly, subdued demand-- both due to stores being shut and lower purchasing power-- is responsible for this downward pressure on prices.  

There is a bit more room for imagination when we look into the future. Some observers warn of the opposite problem-- inflation.  The Treasury and Federal Reserve have pumped in an extraordinary amount of money into the economy, so this could eventually lead to higher price levels.  At this point, though, it difficult to prognosticate if, how, when and which of the two countering forces--dampened demand versus stimulative policies-- will prevail.  

So.....🤷

But then I started looking beyond just the big aggregate headline number, and prices got a lot more interesting.  While overall, the price of the "basket of goods" that the CPI tracks went down, this was not the case for its components.  Take food.  In May, food prices rose 4.8%.  Over the past three months, they’ve risen 4.1% — that’s an annual rate of 17.5%. Beef prices are up 11% in just three months.  The CPI for Meats, poultry, and fish increased 3.9 percent from March 2020 to April 2020 and is up 6.2 percent since April 2019.  Here, supply factors-- closures of meat processing facilities-- were responsible.  Prices of staples like carrots and potatoes also increased due to transportation and health issues among workers.  There is a sense that the higher prices are here to stay.

For the average household in the economy, on a day-to-day basis, this increase in food prices is perhaps more relavent than the CPI as a whole.  As household income goes down, the fraction of food expenditure goes up-- poorer households spend a larger fraction of their income on food. So higher prices hits where it really hurts. This Opinion piece expresses frustrations over the increasing prices of necessities even while prices in other categories are falling: 

Most of us can put off buying clothes for a few months. Most of us have drastically cut back on our transportation spending since the coronavirus hit — there’s no place we want to go. And many people are spending less on health care because, frankly, they are afraid to go to the clinic while this nasty virus is still spreading. But all us have to eat every day or so. And we have to pay the rent and other bills.The absolute necessities are getting more expensive, while the things we can forgo are cheaper.

Long, Winding Road

The "jobs numbers" came out this past Friday, and gave surprised economic forecasters plenty to think about over the weekend.  Almost every forecaster had predicted a net loss of jobs, the best case scenario was a decrease of 800K on payrolls.  So imagine the surprise when the Bureau of Labor Statistics (BLS) reported an increase 2.5 million payroll jobs and the unemployment number fell to 13.3% from 14.7%.  What to make of this seemingly "happy" news?  Here are some points to think about:

True, the growth rate of jobs over the last month was positive. In terms, of level (number) or jobs, the economy is still is in a deep hole.  There are still 21 milion more unemployed people compared to February and the unemployment rate is 9.8 percentage points higher since then.

Whether it is jobs data, GDP data, sales data or medical data, beware of the "yo-yo" effect in a situation like the current one.  Dramatic changes in numbers can make percentages (especially those calculated over short periods of time) misleading.

Second, turns out the BLS is struggling to capture the dynamics of labor market due to this novel virus.  Traditional, the BLS survey does a good job in telling us about the state of the economy, as based on jobs. There is a question on the survey that asks whether a person is employed but is absent from their job "for some other reason" during the past week (jury duty would be categorized this way). Many people, who were furloughed or temporarily laid off, answered this in the affirmative, and were counted as employed but are in fact, unemployed.  The BLS has recognized this issue in their report, and estimates that if these people were re-classified the unemployment rate would have still gone up, but the change would have been from 19.7%  to 16.3%.  

 Mohamed-El-Erian reiterates the previous point about levels vs. growth:

"While welcoming the improvement in the rate of change, we should not lose sight of the overall levels given that Covid-19 has inflicted the biggest shock on the economy since the Great Depression. Whichever of the two unemployment rates you pick (13% or 16%), it is still well above the 10% peak reached during the Great Recession. The 2.5 million jobs reportedly created in May constitute only a small recovery of the 20.5 million lost in April. And pain and suffering are still exhibited every day in long line at many food banks around the country."

Finally, remember the headline unemployment rate number is an overall number.  To get a complete picture of the economy, we should also look at how unemployments fares across different socioeconomic groups, regions or industries.  Top-of-mind for many right now is probably racial heterogeneity in unemployment.  In May, while unemployment fell overall, the Black unemployment rate actually rose slightly from 16.7% to 16.8%.

It remains to be seen how job creation will fare as stimulus measures like the the Paycheck Protection Program wind down, and the longer term prospects for employers becomes clearer.  The path towards economic recovery will likely be a long, winding one which a single unemployment report cannot predict.

Discussion Questions

The Future of Ideas

Let's talk about the good news first. 

Across the world, researchers have responded urgently and rapidly to the pandemic.  The generation of new knowledge in universities, private companies and research institutions spotlights the nation's strong R&D infrastructure.  In this Boston Globe Op-Ed, UMass President Meehan highlights the nation's committment to "exploration and discovery."  The most urgent work concerns studying the virus itself, particularly the development of a vaccine.  The federal government's "Operation Warp Speed"  aims to deliver one by the end of year.  This is truly an incredible feat compared to development of previous vaccines (for example, the mumps vaccine, which held the previous record for speed, took four years).  

The generation of new ideas and knowledge has not been limited to science fields.  For example, the speedy generation of papers in economics, leveraging current data and producing lots of interesting insights regarding the economy, markets, and households has been impressive.  And even "smaller scale" inventions are flourishing.  Take explorations into effective material-- coffee filters, vacuum bags, pantyhose-- for DIY facemasks.  Or the clever ways to social distance. Hey, that's innovation! 

So what's the bad news?

Universities are very worried about what the future will look like.  Their financial status is shaky because they expect drastic decreases in both tuition revenue (especially from international students), and in funding from strained government budgets.  Moreover, the human capital involved in the production of new ideas will also be adversely affected as most graduate students involved in advanced STEM research are foreign. 

To conclude on a hopeful note...

There is bi-partisan support for continued investment in the country's knowledge generation.  The Endless Frontier Act  would provide $100 billion for "sweeping" changes to the National Science Foundation.  The sponsors of the bill write:

“The country that wins the race in key technologies—such as artificial intelligence, quantum computing, advanced communications, and advanced manufacturing—will be the superpower of the future.” 

Discussion Questions

The Dark Side of Exponential Growth

The magical dynamics of exponential growth can lead to wonderful things when it come to GDP per capita--  Japan, South Korea, China and other "growth miracles."  Sadly, however, exponential growth is entirely a curse when it comes to infectious diseases.  The same mathematical forces  that led us to conclude "growing at a rate of 2% per year, the U.S. can double GDPpc in  approximately 35 years" also implies that in the early days of the pandemic, cases were doubling every 3 days.  Exponential growth doesn't seem so groovy anymore, huh?

This week a study by researchers at the Columbia's public health school found that 36000 deaths could have prevented if social distancing measures had been implemented one week earlier than they actually were. Two weeks earlier, 54000 (84% of deaths).   Changing the rate of growth (how many infections spread from person to person) at the right time has a dramatic effect on the subsequent dynamics.

By the way, a common mistake is using the word "exponential" interchangeably with "rapid."  This is not always the case! "Exponential" simply means that some quantity increases in proportion to its current size.  Depending on what your point of reference is, this increase in quantity may or may not be fast.  This article from The Conversation does a super job in breaking down exponential growth not only in the context of COVID19 but also money, pyramid schemes and nuclear reactions. 

As Benjamin Franklin put it: “Money makes money, and the money that money makes, makes more money.” If you could wait long enough, even the smallest investment would become a fortune. But don’t lock up your rainy-day fund just yet. If you invested £100 at 1% per year it would take you over 900 years to become a millionaire. Very few people would accuse the exponential growth associated with their bank account of being large or rapid.

Doesn't it feel a bit unfair that money growing exponentially is not nearly as dramatic as a deadly virus growing exponentially? Reassuringly though, the  growth that characterizes the early days of a pandemic does not last forever, and many efforts to flatten the curve are achieving that goal.

Mathematics is very clear-cut about how, given certain parameters, a quantity will grow.  But turns out human psychology is more fuzzy and human intuition has a hard time realising exponential growth:

A cognitive bias that puzzles millions of people in home-isolation around the globe is the exponential growth bias. Our brain is not wired to think in exponential terms. We can easily estimate where we will get if from our front door, we take 30 steps, but we cannot estimate how far we will get if we take 30 exponential steps [2], that is, double our step each time. 1+2+4+8+16. The answer is, we’d go around the globe 26 times!  Exponential growth bias makes it very hard for citizens to evaluate the status of the pandemic in their countries.

Discussion Questions

How you doin' GDP?

With  so much news, data, indices, prices and all kinds of data to keep an eye on, sometimes I forget about the OG of them all-- GDP.  Beyond the obvious fact, that it is down, what else is going on with it?

It has been about three weeks since the numbers for 2020 Q1 were released by the Bureau of Economic Analysis (BEA).  Production contracted 4.8%. and this was driven by decreases in consumption and investment.  While we cannot officially be put in recession zone yet (NBER needs two consecutive quarters of contraction), this will most certainly happen following the Q2 release. Get ready to see a new gray "recession" bars on GDP charts!  

So how low can we go this quarter?  The Fed Chairman Jerome Powell has a pretty dismal outlook for what the data release at the end of June will show.  Possibly on the order of a 20-30% contraction. This is based on unemployment numbers (which are released more frequently) and also indicators like retail sales which plummeted in April.  This number is particularly worrisome because the US is a consumption economy.  Consumption makes up close to 70% of the GDP and retail sales are almost half of that.  

Powell when asked about the need for a vaccine to treat the illness and put a stop to the coronavirus pandemic, stressed the importance of consumers to the economy. "For the economy to fully recover, people will have to be fully confident, and that may have to await the arrival of a vaccine," he said.

Lastly, not to kick it GDP it is down....but...

Let's also think about what GDP might be not fully measure or just not be able to capture.  That haircut you gave someone in your family? The cleaner air you may be breathing?  All the free YouTube content you are enjoying? Or on a darker note- that loneliness or boredom people are experiencing?  

Discussion Questions

Up, up and away

The picture does say it all:

The unemployment rate skyrocketed, now in the record books as the highest unemployment rate since 1940 (by the way, this number varies quite a bit by demographics).  There is actually reason to believe that the rate may be even higher than 14.7%.

 Reading the BLS FAQs-- there were 8.1 million who responded they were employed but not at work for some "other" reason.  In normal times, few people really pore over this category   The BLS suspects some of these folks were actually unemployed or furloughed but may not have fully understood the question.  Say we re-classified these 8.1 million as unemployed.  The new unemployment rate would be 20%.  So given the strange, unprecedented reasons for this recession, it may be hard to capture the scope of unemployment using the usual survey methodology.  The BLS acknowledges this in their press release.

Another source of labor force data that I found interesting was via LinkedIn.  It tracked how many members added a new employer to their profile.  They saw a 24% decline in this number. (Mind you, this is not a representative sample of the country or any way verified by the government.  It does, however have less lag and when used with other metrics, it can give some neat insights).   Here is a short video.   To end on a good news, there are some sectors like healthcare, tech and finance that are not in terrible shape.