PIIE Global Economic Prospects: Fiscal stimulus worked around the world, but US recovery slows and remains vulnerable

WASHINGTON—The policy response of the last six months has allowed the global economy to recover from the steep drop in activity that occurred when economies shut down to contain the spread of the COVID-19 virus. The recovery in the United States and elsewhere, however, is as yet partial, fragile, and uneven—with fiscal uncertainty and divided labor markets major risks to the US outlook. These and other assessments are being presented today at the Peterson Institute for International Economics (PIIE) semiannual Global Economic Prospects event by PIIE senior fellows Karen Dynan, Jason Furman, and David Wilcox.

All told, Dynan, former chief economist at the US Treasury Department, in her presentation expects US output in 2020 to be 3.8 percent below its level last year. The US unemployment rate is likely to end the year at 7.3 percent, down from a peak of nearly 15 percent in April but still double its pre-pandemic level. The early stages of the US recovery showed a sharp partial rebound in aggregate demand, supported by low interest rates, fiscal stimulus, and pent-up demand. The pace of improvement has slowed in recent months more than in China and in some other major economies, and remains vulnerable to setbacks, particularly in the absence of further fiscal support.

Dynan's baseline forecast calls for the US economy to experience further recovery next year, putting the level of activity about 3 percent below where it would have been in the absence of the pandemic by the end of the year. It is important to emphasize that crucial factors shaping the recovery will be the pace of vaccine development and distribution, the extent of sectoral shifts, and the degree of economic scarring via diminished worker skills, weakened household balance sheets, and business failures.

Furman, former chair of the White House Council of Economic Advisers, documents the substantial and timely initial fiscal response to COVID-19 across all of the advanced economies and especially in the United States. This response has led to rising disposable income even as GDP has plummeted—supporting a rapid rebound of consumption. This fiscal response has ended, and now the fiscal cliff is subtracting from economic growth and causing increased hardship.

While details of policy responses matter, Furman's analysis shows that there is not a large difference in outcomes between the European approach of job retention and the US approach of unemployment insurance, with the US system providing some additional support for the inevitable labor reallocation. Similarly, when Furman analyzes the medium-term fiscal outlook, he finds that the fall in interest rates, and the expectation that they will remain relatively low, has made the fiscal situation of the United States and other countries more sustainable.

In his presentation, Wilcox, former director of the Federal Reserve's Division of Research and Statistics, draws several distinctions between previous recessions and the current economic downturn, in which the collapse of the labor market has been much quicker and more extensive. In just two months—from February to April of this year—job loss was more than twice as great as over the whole of the Great Recession of 2007–09.

This aggregate picture hides significant inequality in outcomes, notes Wilcox. In the past few months, the number of jobs at the top of the income ladder has fully recovered, while the number of jobs at the bottom of the ladder remains more than 20 percent below pre-COVID levels. Meanwhile, food insecurity has roughly doubled. Wilcox argues that these and other forms of differentiation in the experience of the recession—with many at the top more largely insulated from adverse economic effects—could impede a more vigorous policy response, slow the pace of the recovery, and sow the seeds of longer-term damage.