Jerome Powell (photo from the Wall Street Journal)
Most economists believe that monetary policy actions, such as changes in the Fed’s pace of buying bonds or in its target for the federal funds rate, affect real GDP and employment only with a lag of several months or longer. But monetary policy actions can have a more immediate effect on the prices of financial assets like stocks and bonds.
Investors in financial markets are forward looking because the prices of financial assets are determined by investors’ expectations of the future. (We discuss this point in Economics and Microeconomics, Chapter 8, Section 8.2, Macroeconomics, Chapter 6, Section 6.2, and Money, Banking and the Financial System, Chapter 6.) For instance, stock prices depend on the future profitability of firms, so if investors come to believe that future economic growth is likely to be slower, thereby reducing firms’ profits, the investors will sell stocks causing stock prices to decline.
Similarly, holders of existing bonds will suffer losses if the interest rates on newly issued bonds are higher than the interest rates on existing bonds. Therefore, if investors come to believe that future interest rates are likely to be higher than they had previously expected them to be, they will sell bonds, thereby causing their prices to decline and the interest rates on them to rise. (Recall that the prices of bonds and the interest rates (or yields) on them move in opposite directions: If the price of a bond falls, the interest rate on the bond will increase; if the price of a bond rises, the interest rate on the bond will decrease. To review this concept, see the Appendix to Economics and Microeconomics Chapter 8, the Appendix to Macroeconomics Chapter 6, and Money, Banking, and the Financial System, Chapter 3.)
Because monetary policy actions can affect future interest rates and future levels of real GDP, investors are alert for any new information that would throw light on the Fed’s intentions. When new information appears, the result can be a rapid change in the prices of financial assets. We saw this outcome on January 5, 2022, when the Fed released the minutes of the Federal Open Market Committee meeting held on December 14 and 15, 2021. At the conclusion of the meeting, the FOMC announced that it would be reducing its purchases of long-term Treasury bonds and mortgage-backed securities. These purchases are intended to aid the expansion of real GDP and employment by keeping long-term interest rates from rising. The FOMC also announced that it intended to increase its target for the federal funds rate when “labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment.”
When the minutes of this FOMC meeting were released at 2 pm on January 5, 2022, many investors realized that the Fed might increase its target for the federal funds rate in March 2022—earlier than most had expected. In this sense, the release of the FOMC minutes represented new information about future Fed policy and the markets quickly reacted. Selling of stocks caused the S&P 500 to decline by nearly 100 points (or about 2 percent) and the Nasdaq to decline by more than 500 points (or more than 3 percent). Similarly, the price of Treasury securities fell and, therefore, their interest rates rose.
Investors had concluded from the FOMC minutes that economic growth was likely to be slower during 2022 and interest rates were likely to be higher than they had previously expected. This change in investors’ expectations was quickly reflected in falling prices of stocks and bonds.
Sources: An Associated Press article on the reaction to the release of the FOMC minutes can be found HERE; the FOMC’s statement following its December 2021 meeting can be found HERE; and the minutes of the FOMC meeting can be found HERE.
When Congress established the Federal Reserve System in 1913, it intended to make the Fed independent of the rest of the federal government. (We discuss this point in the opener to Macroeconomics, Chapter 15 and to Economics, Chapter 25. We discuss the structure of the Federal Reserve System in Macroeconomics, Chapter 14, Section 14.4 and in Economics, Chapter 24, Section 24.4.) The ultimate responsibility for operating the Fed lies with the Board of Governors in Washington, DC. Members of the Board of Governors are nominated by the president and confirmed by the Senate to 14-year nonrenewable terms. Congress intentionally made the terms of Board members longer than the eight years that a president serves (if the president is reelected to a second term).
The president is still able to influence the Board of Governors in two ways:
The terms of members of the Board of Governors are staggered so that one term expires on January 31 of each even-number year. Although this approach means that it’s unlikely that a president will be able to appoint all seven members during the president’s time in office, in practice, many members do not serve their full 14-year terms. So, a president who serves two terms will typically have an opportunity to appoint more than four members of the Board.
The president nominates one member of the Board to serve a renewable four-year term as chair, subject to confirmation by the Senate.
The terms of Fed chairs end in the year after the year a president begins either the president’s first or second term. As a result, presidents are often faced with what is at times a difficult decision as to whether to reappoint a Fed chair who was first appointed by a president of the other party.
For example, after taking office in January 2009, President Barack Obama, a Democrat, faced the decision of whether to nominate Fed Chair Ben Bernanke to a second term to begin in 2010. Bernanke had originally been appointed by President George W. Bush, a Republican. Partly because the economy was still suffering the aftereffects of the financial crisis and the Great Recession, President Obama decided that it would potentially be disruptive to financial markets to replace Bernanke, so he nominated him for a second term.
After taking office in January 2017, President Donald Trump, a Republican, had to decide whether to nominate Fed Chair Janet Yellen, who had been appointed by Obama, to another term that would begin in 2018. He decided not to reappoint Yellen and instead nominated Jerome Powell, who was already serving on the Board of Governors. Although a Republican, Powell had been appointed to the Board in 2014 by Obama.
President Biden’s reasons for nominating Powell to a second term to begin in 2022 were similar to Obama’s reasons for nominating Bernanke to a second term: The U.S. economy was still recovering from the effects of the Covid-19 pandemic, including the strains the pandemic had inflicted on the financial system. He believed that replacing Powell with another nominee would have been potentially disruptive to the financial system.
There had been speculation that Biden would choose Lael Brainard, who has served on the Board of Governors since 2014 following her appointment by Obama, to succeed Powell as Fed chair. Instead, Biden appointed Brainard as vice chair of the Board. In announcing the appointments, Biden stated: “America needs steady, independent, and effective leadership at the Federal Reserve. That’s why I will nominate Jerome Powell for a second term as Chair of the Board of Governors of the Federal Reserve System and Dr. Lael Brainard to serve as Vice Chair of the Board of Governors.”
Sources: Nick Timiraos and Andrew Restuccia, “Biden Will Tap Jerome Powell for New Term as Fed Chairman,” wsj.com, November 22, 2021; and Jeff Cox and Thomas Franck, “Biden Picks Jerome Powell to Lead the Fed for a Second Term as the U.S. Battles Covid and Inflation,” cnbc.com, November 22, 2021.
The U.S. dollar is the most important currency in the world economy. The funds that governments and central banks hold to carry out international transactions are called their official foreign exchange reserves. (See Macroeconomics, Chapter 18, Section 18.1 and Economics, Chapter 28, Section 28.1.) There are 180 national currencies in the world and foreign exchange reserves can be held in any of them. In practice, international transactions are conducted in only a few currencies. Because the U.S. dollar is used most frequently in international transactions, the majority of foreign exchange reserves are held in U.S. dollars. The following figure shows the composition of official foreign exchange reserves by currency as of mid-2021.
Over time, the percentage of foreign exchange reserves in U.S. dollars has been gradually declining, although the dollar seems likely to remain the dominant foreign reserve currency for a considerable period. Does the United States gain an advantage from being the most important foreign reserve currency? Economists and policymakers are divided in their views. At the most basic level, dollars are claims on U.S. goods and services and U.S. financial assets. When foreign governments, banks, corporations, and investors hold U.S. dollars rather than spending them, they are, in effect, providing the United States with interest-free loans. U.S. households and firms also benefit from often being able to use U.S. currency around the world when buying and selling goods and services and when borrowing, rather than first having to exchange dollars for other currencies.
But there are also disadvantages to the dollar being the dominant reserve currency. Because the dollar plays this role, the demand for the dollar is higher than it would otherwise be, which increases the exchange rate between the dollar and other currencies. If the dollar lost its status as the key foreign reserve currency, the exchange rate might decline by as much as 30 percent. A decline in the value of the dollar by that much would substantially increase exports of U.S. goods. Barry Eichengreen of the University of California, Berkeley, has noted that the result might be “a shift in the composition of what America exports from Treasury [bonds and other financial securities] … toward John Deere earthmoving equipment, Boeing Dreamliners, and—who knows—maybe even motor vehicles and parts.”
As shown in the following figure, the importance of the U.S. dollar in the world economy is also indicated by the sharp increase in the demand for dollars and, therefore, in the exchange rate during the financial crisis in the fall of 2008 and during the spread of Covid-19 in the spring of 2020. (The exchange rate in the figure is a weighted average of the exchange rates between the dollar and the currencies of the major trading partners of the United States.) As an article in the Economist put it: “Last March, when suddenly the priority was to have cash, the cash that people wanted was dollars.”
Sources: International Monetary Fund, “Currency Composition of Official Foreign Exchange Reserves,” data.imf.org; Alina Iancu, Neil Meads, Martin Mühleisen, and Yiqun Wu, “Glaciers of Global Finance: The Currency Composition of Central Banks’ Reserve Holdings,” blogs.imf.org, December 16, 2020; Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, New York: Oxford University Press, 2001, p. 173; “How America’s Blockbuster Stimulus Affects the Dollar,” economist.com, March 13, 2021; and Federal Reserve Bank of St. Louis.
In November 2021, Congress passed and President Joe Biden signed the trillion dollar Infrastructure Investment and Jobs Act, often referred to as the Bipartisan Infrastructure Bill (BIF). The bill included funds for:
Highways and bridges
Buses, subways, and other mass transit systems
Amtrak, the federally sponsored corporation that provides most intercity railroad service in the United States, to modernize and expand its service
A network of charging stations for electric cars
Maintenance and modernization of ports and airports
Securing infrastructure against cyberattacks and climate change
Increasing access to clean drinking water
Expansion of broadband internet, particularly in rural areas
Treating soil and groundwater pollution
As with other infrastructure bills, although the federal government provides funding, much of the actual work—and some of the funding—is the responsibility of state and local governments. For instance, nearly all highway construction in the United States is carried out by state highway or transportation departments. These state government agencies design new highways and bridges and contract primarily with private construction firms to do the work.
Because state and local governments carry out most highway and bridge construction, Congress doesn’t always achieve the results they intended when providing the funding. Bill Dupor, an economist at the Federal Reserve Bank of St. Louis, has discovered a striking example of this outcome. In 2009, in response to the Great Recession of 2007–2009, Congress passed and President Barack Obama signed the American Recovery and Reinvestment Act (ARRA). (We discuss the ARRA in Macroeconomics, Chapter 16, Section 16.5 and Economics, Chapter 26, Section 26.5.) Included in the act was $27.5 billion in new spending on highways. This amount represented a 76 percent increase on previous levels of federal spending on highways. As Dupor puts it, Congress and the president had “great hopes for the potential of these new grants to create and save construction jobs as well as improve highways.”
Surprisingly, though, Dupor’s analysis of data on the condition of bridges, on miles of highways constructed, and on the number of workers employed in highway construction shows that the billions of dollars Congress directed to infrastructure spending under ARRA had little effect on the nation’s highways and bridges and did not increase employment on highway construction.
What happened to the $27.5 billion Congress had appropriated? Dupor concludes that after receiving the federal funds most state governments:”cut their own contributions to highway capital spending which, in turn, … [freed] up those funds for other uses. Since states were facing budget stress from declining tax revenues resulting from the recession, it stands to reason that states had the incentive to do so.”
He finds that following passage of ARRA many states cut their spending on highway infrastructure while at the same time increasing their spending on other things. For instance, Maryland cut its spending on highways by $73 per person while increasing its spending on education by $129 per person.
Can we conclude that that Congressional infrastructure spending under ARRA was a failure and the funds were wasted? To answer this question, first keep in mind that when it authorizes an increase in infrastructure spending, Congress often has two goals in mind:
To maintain and expand the country’s infrastructure
To engage in countercyclical fiscal policy
The first goal is obvious but the second can be important as well. Typically, Congress is most likely to authorize a large increase in infrastructure spending during a recession. When the ARRA was passed in the spring of 2009, Congress and President Obama were clear that they hoped that the increased spending authorized in the bill would reduce unemployment from the very high levels at that time. (Economists and policymakers debated whether additional countercyclical fiscal policy was needed at the time Congress passed the BIF in late 2021. Although the Biden administration argued that the spending was needed to increase employment, some economists argued that the BIF did little to deal with the supply problems then plaguing the economy.)
We discuss in Macroeconomics, Chapter 16, Section 16.2 (Economics, Chapter 26, Section 26.2), how expansionary fiscal policy can increase real GDP and employment during a recession. If Dupor’s analysis is correct, Congress failed to achieve its first goal of improving the country’s infrastructure. But Dupor’s findings that states, in effect, used the federal infrastructure funds for other types of spending, such as on education, means that Congress did meet its second goal. That conclusion holds if in the absence of receiving the $27.5 billion in funds from ARRA, state governments would have had to cut their spending elsewhere, which would have reduced overall government expenditures and reduced aggregate demand.
As this discussion indicates, the details of how fiscal policy affects the economy can be complex.
Sources: Gabriel T. Rubin and Eliza Collins, “What’s in the Bipartisan Infrastructure Bill? From Amtrak to Roads to Water Systems,” wsj.com, November 6, 2021; Bill Dupor, “So Why Didn’t the 2009 Recovery Act Improve the Nation’s Highways and Bridges?” Federal Reserve Bank of St. Louis Review, Vol. 99, No. 2, Second Quarter 2017, pp. 169-182; Greg Ip, “President Biden’s Economic Agenda Wasn’t Designed for Shortages and Inflation,” wsj.com, November 10, 2021; and Executive Office of the President, “Updated Fact Sheet: Bipartisan Infrastructure Investment and Jobs Act,” whitehouse.gov, August 2, 2021.
When Deng Xiaoping assumed control of China following the death of Mao Zedong in 1976, he was in charge of one of the poorest countries in the world. The average person in China survived on the equivalent of $3 per day and the bulk of the population worked on government-run collective farms. Deng’s response to this dismal situation was a series of economic reforms that led China away from Mao’s socialist regime toward a free market economy. The results have been spectacular.
Since 1978, when Deng’s reforms began, real GDP per capita in China has increased from $381 (in 2010 prices) to $10,431 in 2020. Today, China is a solidly middle-income country on a par with Mexico or Indonesia. According to World Bank data, in 1981 more than 875 million people in China lived in extreme poverty. By 2019, fewer than 1 million did. The world has never seen such a high economic growth rate sustained over such a long period or as dramatic a reduction in poverty in such a short period. Deng brought about an increase in the material well-being of his people unrivaled in history.
But, as we discuss in the Apply the Concept in Section 11.5 of Chapter 11 in Macroeconomics (Section 21.5 in Chapter 21 of Economics), despite Deng’s success he failed to resolve a conflict at the heart of the Chinese system: Deng and the other party leaders saw their economic reforms as strengthening socialism and not as replacing socialism with capitalism. They had no intention of undermining the role of the Communist Party in Chinese society or of introducing democracy. The result is the peculiar situation China now finds itself in under current leader Xi Jinping: A country that extensively relies on free markets ruled by an autocratic regime that justifies its dictatorship as necessary for the preservation of socialism.
In 2022, at the 20th Congress of the Chinese Communist Party, Xi seems likely to be elected to a third term as leader of the Communist Party, breaking with the tradition since Deng of leaders serving only two terms. Like Mao, Xi’s apparent intention is to retain his office indefinitely. Xi’s speeches indicate that he believes that China is following a path like the one that Karl Marx, writing in the 1800s, believed countries would follow, which would culminate in a socialist economy. He sees Mao as having reasserted China’s independence from Europe and the United States, although at his death China remained largely rural and agricultural with very little scope for market activity. Deng continued the evolution of the economy by establishing a market system that raised incomes and allowed for industrial development. Xi sees himself as finishing the process by leading China to become a “modern socialist nation” by 2035.
As we discuss in the Apply the Concept, there are a number of obstacles to China’s continued economic growth, obstacles that appear to have increased during 2021 as Xi’s plans have become clearer.
As part of his plan to transition China to being a socialist nation, Xi has increased government regulation of China’s economy. He has imposed large fines on technology firms such as Alibaba and Tencent and on the ride-hailing firm Didi. A government proclamation effectively ended the for-profit school tutoring industry, which seven of ten Chinese students had been using. This government action raised concern among the owners of some small and medium-sized businesses that their investments in their firms could be wiped out arbitrarily without notice. Wealthy Chinese entrepreneurs were also being pressured to devote more funds to charity. Whether increased government regulation will result in entrepreneurs pulling back from the investment needed to sustain economic growth remains to be seen.
Over the decades since market reforms began, the Chinese economy had been cutting reliance on production by state-owned enterprises (SOEs) in favor of production by private firms. Recently, some observers have concluded that Xi plans to increase the share of the economy controlled by SOEs, although his public statements have emphasized the need for SOEs to become more efficient and for the government to reduce its subsidies to these firms. Many of China’s trading partners, including the United States, have objected to these subsidies. If the importance of SOEs in the Chinese economy should increase, it would likely further slow economic growth and increase the frictions between China and its trading partners.
Economic growth has been slowing down. Between 1978 and 2011, per capita real GDP grew at an annual average rate of 8.9 percent. Between 2012 and 2020 that growth rate slowed to 6.0 percent. Although compared with most other countries, a 6 percent growth rate is quite high, some economists believe that the Chinese government has been overstating the true growth rate. As an article in the Wall Street Journal put it, “real growth has long been one of the ways officials are evaluated in China, and so there is a strong incentive to inflate it—and substantial evidence that has happened.”
China’s population is rapidly aging. Its birthrate of 1.3 children born per woman during her lifetime is well below the rate of 2.1 needed to maintain the population. The working age population has been declining since 2011, as the fraction of the population over 65 has been increasing. Although the populations of Europe, the United States, and other high-income countries have also been aging, those countries have more resources than does China to provide support to retired people, as with the Social Security and Medicare programs in the United States. Because China’s average retirement age is only 54, while its average life expectancy is 77 years, an increasing number of retirees is being supported by a decreasing number of workers. The Chinese government has announced plans to raise the official retirement age but the government has abandoned past attempts to do so in the face of public protests.
The economy’s excessive reliance on investment in real estate. Particularly during the past five years, real estate investment has been an important contributor to the growth of the Chinese economy, accounting for as much as 25 percent of GDP (as opposed to only about 7 percent in the United States). But the difficulties that the Evergrande real estate development firm encountered during 2021 seemed to be an indication that what has been the largest real estate boom in history may be ending. In some cities as many as 40 percent of apartments are empty, making it difficult for Evergrande and other developers to make the interest payments on their loans and bonds. The Chinese government has issued regulations that limit borrowing by real estate developers in an attempt to reduce what the government sees as speculative building of apartments. Whether the government can reduce the importance of real investment in the economy without causing a significant reduction in the economy’s growth rate is uncertain.
Increasing political problems with other countries. The Chinese government has drawn sharp international criticism for a number of actions: Its repression of the more than one million members of a Muslim minority in western China; its ending the political independence of Hong Kong; the expansion of its military and its threatening actions towards Taiwan (which the Chinese government believes is part of China); and its failure to be forthcoming with information about the origins of the Covid-19 virus. An additional source of disagreements with other governments has been disputes over international trade. Both the Trump and Biden administrations, as well as governments in Europe, have been critical of the Chinese government forcing foreign firms that operate in China to transfer intellectual property to Chinese firms, an action that is in violation of the World Trade Organization’s (WTO) rules. The growth of Chinese exports has been greatly helped by China’s membership in the WTO, which may be threatened by what other governments see as China’s violations of WTO rules.
The actions that Xi Jinping takes in the coming years are likely to have a large effect on not just the Chinese economy, but on the world economy.
Sources: Stella Yifan Xie, “China’s Economy Faces Risk of Yearslong Real-Estate Hangover,” wsj.com, November 8, 2021; “Xi Jinping Is Rewriting History to Justify His Rule for Years to Come,” economist.com, November 6, 2021; Sofia Horta e Costa, “Chinese Developer Controlled by Government Is Latest to Plunge,” bloomberg.com, November 8, 2021; Kevin Rudd, “What Explains Xi’s Pivot to the State?” wsj.com, September 19, 2021; “At 54, China’s Average Retirement Age Is Too Low,” economist.com, June 26, 2021; Nathaniel Taplin, “China’s Economic Data: A Guide for the Dazed and Confused,” wsj.com, January 4, 2021; Stella Yifan Xie and Mike Bird, “The $52 Trillion Bubble: China Grapples With Epic Property Boom,” wsj.com, July 16, 2020; the World Bank; and the Federal Reserve Bank of St. Louis.
There are many macroeconomic forecasts. Some forecasts are made by private economists, including those who work for Wall Street Investment firms. Other forecasts are made by economists who work for the government. Perhaps the most widely used macroeconomic forecasts are those published by economists who work for the Congressional Budget Office (CBO). The CBO is a nonpartisan agency within the federal government that provides estimates of the economic effects of government policies as part of the process by which Congress prepares the federal budget. One important aspect of the CBO’s work is to estimate future federal government budget deficits.
To forecast the size of future deficits, the CBO needs to forecast growth in key macroeconomic variables, including GDP. Faster growth in the U.S. economy should result in faster growth in federal tax revenues and slower growth in federal government transfer payments, including payments the federal government makes under the unemployment insurance system, the Temporary Assistance for Needy Families program, and the Supplemental Nutrition Assistance Program. When revenues grow faster than expenditures, the federal budget deficit shrinks.
The CBO’s forecasts of potential GDP provide perhaps the most best known projections of the future economic growth of the U.S. economy. The CBO calculates its forecasts of potential GDP by forecasting the variables that potential GDP depends on. As we’ve seen in Macroeconomics, Chapters 10 (Economics, Chapters 20), the two key variables in determining the growth in real GDP are the growth in labor productivity—the ratio of real GDP to the quantity of labor—and the growth of the labor force.
How well has the CBO forecast future U.S. economic growth? Or, equivalently, how well has the CBO forecast potential GDP. Each year the CBO publishes forecasts of potential GDP for the following 10 years and for longer periods—typically 40 or 50 years. Claudia Sahm, an economic consultant and opinion writer and formerly an economist at the Federal Reserve and the White House, has noted that the CBO’s 10-year forecasts of potential GDP have not been good forecasts of the actual growth of real GDP. Over the past 15 years, the CBO has also carried out surprisingly large downward revisions of its forecasts of potential GDP.
The figure below is similar to one prepared by Sahm and shows the forecasts of potential GDP the CBO published in 2005, 2010, 2015, and 2020 for the following 10 years. (For Sahm’s Twitter thread discussing her figure, click HERE.) That is, in 2005, the CBO issued a forecast of potential GDP for the years 2005–2015. In 2010, the CBO issued a forecast of potential GDP for the years 2010–2020, and so on. Note that for ease of comparison, all GDP values in the figure are set equal to a value of 100 in 2005.
Each straight line on the chart represents the CBO’s forecast of potential GDP over the 10 years following the year in which the forecast was published. For example, the top blue line represents the forecasts the CBO made in 2005 of the values of potential GDP for the years 2005 to 2015. The bottom blue line shows the actual values of real GDP for the years from 2005 to 2020. Note how at each five year interval, the CBO’s forecasts of potential GDP shifted down.
We can look at a few examples of how far off the CBO’s projections were. For instance, if the economy had grown as rapidly between 2005 and 2015 as the CBO forecast it would in 2005, real GDP would have been about 15 percent higher than it actually was. In other words, the U.S. economy would have produced about $2.5 trillion more in goods and services than it actually did. Similarly, if the economy had grown as rapidly between 2010 and 2019 as the CBO forecast it would in 2010, real GDP in 2019 would have been about 7.5 percent (or about $1.5 trillion) higher than it actually was.
Why has the CBO persistently overestimated the future growth rate of the U.S. economy? The main source of error has been the CBO’s overestimation of the growth in labor force productivity. They have also slightly overestimated the growth of the labor force. Claudia Sahm has a more basic criticism of the CBO’s approach to estimating potential GDP. She argues that if real GDP grows slowly during a period, perhaps because monetary and fiscal policies are insufficiently expansionary, the CBO will incorporate the lower actual real GDP values when it updates its forecasts of potential GDP. This approach can raise questions as to whether the CBO is actually measuring potential GDP as most economist’s define it (and as we define it in the textbook): The level real GDP attains when all firms are producing at capacity. Other economists share these concerns. For instance, Daan Struyven, Jan Hatzius, and Sid Bhushan of the Goldman Sachs investment bank, argue that the CBO’s estimate of potential GDP understates the true capacity of the U.S. economy by 3 to 4 percent.
The CBO’s substantial adjustments to its forecasts of potential GDP are another indication of how volatile the U.S. economy has been since the beginning of the 2007–2009 recession.
Sources: Tyler Powell, Louise Sheiner, and David Wessel, “What Is Potential GDP, and Why Is It So Controversial Right Now,” brookings.edu, February 22, 2021; and Congressional Budget Office, “Budget and Economic Data,” various years.
There are a number of ways in which the Covid-19 pandemic was unlike anything the United States has experienced since the 1918 influenza pandemic. Most striking from an economic perspective were the extraordinary swings in real GDP. The following figure shows quarterly changes in real GDP seasonally adjusted and calculated at an annual rate. There were three recessions during this period (shown by the shaded areas).
The first of these recessions occurred during 2001 and was similar to most recessions in the United States since 1950 in being short and relatively mild. Real GDP declined by 1.5 percent during the third quarter of 2001. The recession of 2007–2009 was the most severe to that point since the Great Depression of the 1930s. The worst periods of the 2007–2009 were the fourth quarter of 2008, when real GDP declined by 8.5 percent—the largest decline to that point during any quarter since 1960—and the first quarter of 2009, when real GDP declined by 4.6 percent.
Turning to the 2020 recession, during the first quarter of 2020, only at the end of which did Covid-19 begin to seriously affect the U.S. economy, real GDP declined by 5.1 percent. Then in the second quarter a collapse in production occurred unlike anything previously experienced in the United States over such a short period: Real GDP declined by 31.2 percent. But that collapse was followed in the next quarter by an extraordinary recovery in production when real GDP increased by 33.8 percent—by far the largest increase in a single quarter in U.S. history.
The following figure shows the changes in the components of real GDP during the second and third quarters of 2020. In the second quarter of 2020, consumption spending declined by about the same percentage as GDP, but investment spending declined by more, as many residential and commercial construction projects were closed. Exports declined by nearly 60 percent and imports declined by nearly as much as many ports were temporarily closed. In the third quarter of 2020, many state and local governments relaxed their restrictions on business operations and the components of spending bounced back, although they remained below their levels of late 2019 until mid-2021.
Even when compared with the Great Depression of the 1930s, the movements in real GDP during the Covid-19 pandemic stand out for the size of the fluctuations. The official U.S. Bureau of Economic Analysis data on real GDP are available only annually for the 1930s. The following figure shows the changes in these annual data for the years 1929 to 1939. As severe as the Great Depression was, in 1932, the worst year of the downturn, real GDP declined by less than 13 percent—or only about a third as much as real GDP declined during the worst of the 2020 recession.
We have to hope that we will never again experience a pandemic as severe as the Covid-19 pandemic or fluctuations in the economy as severe as those of 2020.
Source: U.S. Bureau of Economic Analysis. Note: Because the BEA doesn’t provide an estimate of real GDP in 1928, our value for the change in real GDP during 1929 is the percentage change in real GDP per capita from 1928 to 1929 using the data on real GDP per capita compiled by Robert J. Barro and José F. Ursúa. LINK
During 2020, Congress and President Donald Trump responded to the Covid-19 pandemic with very aggressive fiscal policy initiatives. First, in March 2020, Congress enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act increased the federal government’s expenditures by $1.9 trillion. Then, in December 2020, in response to the continuing effects of the pandemic, Congress and President Trump included an additional $915 billion in expenditures related to Covid-19 in the Consolidated Appropriations Act. These two fiscal policy actions included payments directly to households and supplemental unemployment insurance payments. Higher income households were not eligible for the direct payments (often referred to as “stimulus payments”). Higher income households were also less likely to be unemployed and so were less likely to receive the supplemental unemployment insurance payments.
In Chapter 17, Section 17.4, we discuss the unequal distribution of income in the United States. Because the federal payments were targeted toward lower and middle income households, did the payments result in a decline in income inequality? Table 17.6 in Chapter 17, shows a common measure of the distribution of income: Households in the United States are divided into five income quintiles, from the 20 percent with the lowest incomes to the 20 percent with the highest incomes, along with the fraction of total income received by each of the five groups. The following table displays the distribution of income using this measure for 2019 and 2020. (We also include the data for the share of income received by the 5 percent of households with the highest incomes.) Note that the definition of income used in the table includes tax payments households make in that year in addition to payments—including the stimulus payments—received from the government. The income is also “equivalence adjusted,” which means that income is adjusted to account for how many adults and children are in a household.
Year
Lowest 20%
Second 20%
Middle 20%
Fourth 20%
Highest 20%
Highest 5%
2019
4.7%
10.4%
15.7%
22.6%
46.6%
19.9%
2020
5.1%
10.9%
16.0%
22.8%
45.2%
18.9%
Percentage change in income share
8.7%
4.8%
2.1%
0.8%
−3.0%
−5.1%
The table shows that the distribution of income in the United States became somewhat more equal during 2020, with the share of income going to each of the first four quintiles increasing, while the income of the highest quintile declined. The income share of the lowest quintile increased the most—by 8.7 percent—while the income share of the top 5 percent of households decreased by 5.1%. In that section of Chapter 17, we discuss the Gini coefficient, which is a measure of how unequal the distribution of income is. The Gini coefficient ranges between 0 and 1 with higher values indicating a more unequal distribution. Between 2019 and 2020, the Gini coefficient decline from 0.416 to 0.399, or by 4.1 percent, which measure the extent to which the income distribution became more equal.
Will the reduction in income inequality the United States experienced during 2020 persist? It seems likely to, at least through 2021, given that in March 2021, Congress and President Joe Biden enacted the American Rescue Plan, which included payments to households of up to $1,400 per eligible household member. As with the payments to households made during 2020, high-income households were not eligible. Congress also extended supplemental unemployment insurance payments through early September 2021 in states that were willing to accept the payments.
What about after federal stimulus payments to households end? (As of late 2021, it appeared unlikely that Congress and President Biden planned on enacting any further payments.) One indication that some of the reduction in inequality might be sustained comes from the sharp increases in the wages of many low-skilled workers. For instance, in October 2021, the wages (as measured by their average hourly earnings) of workers in the leisure and hospitality industry, which includes workers in restaurants and hotels, increased by nearly 12 percent over the previous year. For all workers in the private sector, wages increased by about 5 percent over the same period. Many of the workers in this industry have low incomes. So, the fact that their wages were increasing more than twice as fast as wages in the overall economy indicates that at least some low-income workers were closing the earnings gap with other workers.
Sources: Emily A. Shrider, Melissa Kollar, Frances Chen, and Jessica Semega, U.S. Census Bureau, Current Population Reports, P60-270, Income and Poverty in the United States: 2020, Washington, DC, U.S. Government Printing Office, September 2021, Table C-3; and U.S. Bureau of Labor Statistics.
Northampton County Community College in Pennsylvania
People who graduate from college earn significantly more and have lower unemployment rates than do people who have only a high school degree. (We discuss this issue in Chapter 16, Section 16.3.) As the following table shows, in 2020, people with a bachelor’s degree had average weekly earnings of $1,305 and had an unemployment rate of 5.5 percent, while people who had only a high school degree had weekly earnings of $781 and an unemployment rate of 9.0 percent. People with an associate’s degree from a two-year community college were in between the other two groups.
Educational attainment
Median usual weekly earnings ($)
Unemployment rate (%)
Doctoral degree
1,885
2.5
Professional degree
1,893
3.1
Master’s degree
1,545
4.1
Bachelor’s degree
1,305
5.5
Associate’s degree
938
7.1
Some college, no degree
877
8.3
High school diploma
781
9
Less than a high school diploma
619
11.7
Total
1,029
7.1
Not surprisingly, attempts to reduce income inequality have often included plans to increase the number of low-income people who attend college. In 2021, President Joe Biden proposed a plan that would cover the tuition of most first-time students attending community college in states that agreed to participate in the plan. The plan was estimated to cost $109 billion over 10 years and would potentially cover 5.5 million students. As of late 2021, it appeared unlikely that Congress would enact the plan but similar plans have been proposed in the past making the economic payoff to free community college an important policy issue.
There are many federal, state, and local programs that already cover some or all of the tuition and fees for some community college students. The state and local programs are often called “promise programs.” The name refers to what is usually considered the first such program, which began in Kalamazoo, Michigan in 2005. There are now more than 200 promise programs in 41 states. The programs differ in the percentage of a student’s tuition and fees that are covered and on which students are eligible. The plan proposed by President Biden would have differed from existing programs in being more comprehensive—covering community college tuition for all high school graduates who had not previously attended college.
We can’t offer here a full assessment of the economic effects that might result from a nationwide free community college, but we can briefly summarize some of the very large number of economic studies of community colleges. Hieu Nguyen of Illinois Wesleyan University has studied the effects of the Tennessee Promise program, which beginning in fall 2015, has covered that part of the tuition not covered by federal or other state programs for any Tennessee high school graduate who enrolls in a public two-year college in the state. Nguyen’s analysis finds that the program had a very large effect, increasing “full-time first-time undergraduate enrollment at the state’s community colleges by at least 40%.” Some policymakers and economists are concerned that promise programs may divert some students into attending community college who would otherwise have enrolled in a four-year college. As the table shows, on average, people who graduate from a four-year college have higher incomes and lower unemployment rates than people who graduate from a two-year college. Nguyen analysis indicates that this problem was not significant in Tennessee. He finds that the Tennessee Promise program resulted in only a 2 percent decline in enrollment in Tennessee’s public four-year colleges.
Oded Gurantz of the University of Missouri studied the Oregon Promise program, which like the Tennessee Promise program, covers the part of tuition at Oregon two-year colleges not covered by federal or other state programs with the difference that it awards $1,000 per year to students whose tuition is completely covered from other sources. The program began in 2016. Guarantz finds that although the program did increase the enrollment in two-year colleges by four to five percent, initially nearly all of the increase was the result of students shifting away from four-year colleges. He finds that in later years the program was effective in increasing enrollment in both two-year and four-year colleges.
Elizabeth Bell of Miami University finds that a narrowly focused Oklahoma program that covers tuition and fees at a single two-year college—Tulsa Community College—succeeds in substantially increasing the number of students who transfer to a four-year college and, to a lesser extent, increasing the fraction of students who receive degrees from four-year colleges.
A number of researchers have studied the returns to individuals from attending community college. As with the returns from four-year colleges, choice of major can be very important. Michael Grosz of the Federal Trade Commission found that, controlling for the individual characteristics of students, receiving a degree in nursing from a California community college “increases earnings by 44 percent and the probability of working in the health care industry by 19 percentage points.”
Jack Mountjoy of the University of Chicago has compiled a large data set for the state of Texas that links enrollment in all public and private universities in the state to students’ earnings later in life. Mountjoy uses the data to analyze the effects of community college on upward mobility. The upward mobility of students who attend a community college is increased if the students would otherwise not have attended college but hindered if they attend a community college rather a four-year college they were qualified to attend. Mountjoy notes that survey evidence indicates that 81 percent of students enrolling in two-year colleges intend to ultimately receive a degree from a four-year college, buy only 33 percent transfer to a four-year college within six years and only 14 percent ultimately earn a bachelor’s degree.
Because so few students who enroll in a two-year college ultimately receive a degree from a four-college, promise programs run the risk of actually reducing the number of students who receive bachelor’s degrees by diverting some students from four-year colleges to two-year colleges. Mountjoy’s analysis of the Texas data indicates that “broad expansions of 2-year college access are likely to boost the upward mobility of students ‘democratized’ into higher education from non-attendance, but more targeted policies that avoid significant 4-year diversion may generate larger net benefits.” He notes that for low-income students, “2-year college enrollment may involve other labor market benefits … beyond modest increases in formal educational attainment, such as better access to employer networks, short course sequences teaching readily-employable skills, and improved job matching.”
Mountjoy’s results reinforce a point made by some other economists and policymakers: Programs that provide free community college for all students may be a less effective way for governments to spend scarce funds than are programs that focus on boosting the ability of low-income students to attend and complete both two-year and four-year colleges. Many low-income students face barriers beyond difficulty affording tuition, including the lost earnings from time spent in class and studying rather than working, child care expenses, and paying for textbooks and other learning materials. In addition, providing free tuition at community colleges to all students may end up subsidizing college attendance for some middle and high-income students who would have attended college without the subsidy and may provide an incentive for some students to enroll in two-year colleges who would have been better off enrolling in four-year colleges.
Sources: Julie Bykowicz and Douglas Belkin, “Why Biden’s Plan for Free Community College Likely Will Be Cut From Budget Package,” wsj.com, October 21, 2021; Michel Grosz, “The Returns to a Large Community College Program: Evidence from Admissions Lotteries,” American Economic Journal: Economic Policy; Vol. 12, No. 1, February 2020; 226-253; Hieu Nguyen, “Free College? Assessing Enrollment Responses to the Tennessee Promise Program,” Labour Economics, Vol. 66, October 2020; Oded Guarantz, “What Does Free Community College Buy? Early Impacts from the Oregon Promise,” Journal of Policy Analysis and Management, Vol. 39, No. 1 October 2020, pp. 11-35; Elizabeth Bell, “Does Free Community College Improve Student Outcomes? Evidence From a Regression Discontinuity Design,” Educational Evaluation and Policy Analysis, Vol. 43, No. 2, June 2021, pp. 329-350; Michael Grosz, “The Returns to a Large Community College Program: Evidence from Admissions Lotteries,” American Economic Journal: Economic Policy, Volume 12, No. 1, February 2020; pp. 225-253; Jack Mountjoy, “Community Colleges and Upward Mobility,” National Bureau of Economic Research, Working Paper 29254, September 2021; Allison Pohle, “What Does Biden’s Plan for Families Mean for Community College, Pre-K?” wsj.com, April 28, 2021; Meredith Billings, “Understanding the Design of College Promise Programs, and Where to Go from Here,” brookings.edu, September 18, 2018; and U.S. Bureau of Labor Statistics, “Employment Projections: Education Pays,” Table 5.1, September 8, 2021.
Few diseases affect all demographic groups equally. For example, the 1918–1919 influenza pandemic killed an unusually large number of young adults. Estimates are that half of deaths in the United States during that pandemic occurred among people aged 20 to 40. In recent flu seasons, the elderly have much higher mortality rates than do other age groups. For instance, during the 2018–2019 flu season, people 65 and older died at a rate more than 10 times greater than people 18 to 49 years old. The very young also have comparatively high mortality rates from the flu. In 2018–2019, children 0 to 4 years-old died at a rate six times higher than children 5 to 17 years-old.
When the Covid-19 virus began to spread widely in the United States in the spring of 2020, some epidemiologists expected that it would affect different demographic groups in about the same way that the flu does. In fact, though, while people 65 and older were particularly at risk, young children were less affected by Covid-19 than they are by the flu. The following chart prepared by the Centers for Disease Control and Prevention (CDC) displays for the United States data on Covid deaths by age group as of early November 2021.
The blue bars show the percentage of total deaths from Covid since the beginning of the pandemic represented by that age group and the gray bars show the percentage that group makes up of the total U.S. population. Therefore, an age group that has a gray bar longer than its blue bar was proportionally less affected by the virus and an age group that has a blue bar longer its gray bar was proportionally more affected by the virus. The chart shows that people over age 65 experienced particularly high mortality rates. Strikingly, people over age 85 accounted for nearly 30 percent of all deaths in the United States, while making up only 2 percent of the U.S. population.
The following chart displays data on Covid deaths by gender. Men account for about 49 percent of the U.S. population but have accounted for about 54 percent of Covid deaths.
Finally, the following chart displays data on Covid deaths by race or ethnicity. Hispanic, Black, and American Indian or Alaskan Native people have experienced proportionally higher Covid mortality rates than have Asian or white people.
What explains the disparity in mortality rates across demographic groups? With respect to age, we would expect older people to have weaker immune systems and therefore be more likely to die from any illness. In addition, early in the pandemic many older people in nursing homes died of Covid before it was widely understood that the disease spread through aerosols and that keeping people close together inside unmasked made it easy for the virus to spread. The very young have immature immune systems, which might have made them particularly susceptible to Covid, but for reasons not well understood, they turned not to be.
There continues to be debate over why men have experienced a higher mortality rate from Covid than have women. Vaccination rates among men are somewhat lower than among women, which may account for part of the difference. In an opinion column in the New York Times, Dr. Ezekiel Emanuel of the University of Pennsylvania noted that researchers at Yale University have observed “that there are well-established differences in immune responses to infections between men and women.” But why this pattern should be reflected in Covid deaths is unclear at this point.
Medical researchers and epidemiologists have also not arrived at a consensus in explaining differences in mortality rates across racial or ethnic groups. Groups with higher mortality rates have had lower vaccination, which explains some of the difference. Groups with higher mortality rates are also more likely to suffer from other conditions, such as hypertension, that have been identified as contributing factors in some Covid deaths. These groups are also less likely to have access to health care than are the groups with lower mortality rates. The CDC notes that: “Race and ethnicity are risk markers for other underlying conditions that affect health, including socioeconomic status, access to health care, and exposure to the virus related to occupation, e.g., frontline, essential, and critical infrastructure workers.”
Sources: Ezekiel J. Emanuel, “An Unsolved Mystery: Why Do More Men Die of Covid-19?” nytimes.com, November 2, 2021; Daniela Hernandez, “Covid-19 Vaccinations Proceed Slowly Among Older Latino, Black People,” wsj.com, March 2, 2021; Anushree Dave, “Half-Million Excess U.S. Deaths in 2020 Hit Minorities Worse,” bloomberg.com, October 4, 2021; Centers for Disease Control and Prevention, “Hospitalization and Death by Race/Ethnicity,” cdc.gov, September 9, 2021; Centers for Disease Control and Prevention, “Demographic Trends of COVID-19 cases and deaths in the US reported to CDC,” cdc.gov, November 5, 2021 Centers for Disease Control and Prevention, “2018–2019 Flu Season Burden Estimates,” cdc.gov; and Jeffery K. Taubenberger and David M. Morens, “1918 Influenza: the Mother of All Pandemics,” Emerging Infectious Diseases, Vol. 12, No. 1, January 2006, pp. 15-22.
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