The most imminent threat to the economic recovery may not be a resurgence of the novel coronavirus but a resurgence of fiscal austerity.
In both Canada and the United States, governments have spent lavishly in recent months to support household finances devastated by lockdowns.
The support programs have created a Bizarro economy in which households can find themselves flush with cash despite having lost jobs in the middle of the biggest economic downturn in decades. Savings rates are skyrocketing as money pours into people’s pockets but closed shops and shuttered restaurants limit opportunities for spending.
The growing pools of cash have, quite predictably, spurred calls for paring back support. In Washington, Republicans are expressing concerns about extending emergency support programs past July.
But a premature swing to austerity would be a big mistake for the U.S., according to Sri Thanabalasingam, senior economist at Toronto-Dominion Bank.
The danger, he wrote in a report last week, is that if a quick end to support programs combines with a still-dismal jobs market it will create a sudden, steep drop in household incomes. Such a decline could evolve into a self-perpetuating downturn if the drop in demand goes on to discourage investment and hiring.
What is needed to avoid that danger is continued support for households until a recovery is clearly in place. “It is crucial that the U.S. Congress be ready to provide further assistance to households through these desperate times, especially if the labour market recovery appears shaky,” Mr. Thanabalasingam argues.
His report underlines the risks around the next phase of pandemic management. So far, public-health measures have proved effective in containing infections in Canada, Europe, China and parts of the United States. But as economies begin to reopen, many issues remain in doubt.
One key question is how much of the cash that governments are pouring into consumers’ pockets will actually filter through into the rest of the economy. Cautious consumers may simply bank it as a precautionary buffer against future turbulence rather than splurging at reopened stores and restaurants.
In Canada, generous government support programs, such as the recently extended Canada Emergency Response Benefit, mean that household income is likely to hold up well this year, according to Pedro Antunes, chief economist at the Conference Board of Canada.
“This, coupled with a steep drop in consumer spending, means that households’ savings will swell,” he says. But what happens next hinges on consumer confidence. “The situation is somewhat like pulling back a slingshot – consumers have income and pent-up demand, but will they let go the sling and start spending?”
The same question can be asked in the U.S., but on a much grander scale. In April, total wages across the country dropped by US$1-trillion, says Frances Donald, global chief economist at Manulife Investment Management. However, government transfers to households jumped by US$3-trillion. Result: Personal income jumped by US$2-trillion.
For now, the extra trillions are mostly being saved, resulting in the highest personal savings rate in decades. Those dollars could fuel a major consumption boom over the next few months – but only if consumers feel confident enough to spend.
Continued government support is needed to ensure that the necessary level of confidence exists, according to observers such as Mr. Thanabalasingam at TD.
Democrats concur. They have been pushing for an extension to January of US$600 a week in emergency unemployment insurance payments to Americans who have lost their jobs. At the moment, the aid is scheduled to expire on July 31.
Republicans dispute the need for an extension. Some are in favour of ending the program or want to see it restructured to provide more incentives for going back to work.
For his part, Federal Reserve chair Jerome Powell endorsed continued support of some type when he testified last week to Congress.
“There are something like 25 million people who have been dislodged from their jobs either in full or in part due to the pandemic,” he told the House of Representatives financial services committee on Wednesday. “It would be a concern if Congress were to pull back from the support that it’s providing too quickly.”
That earned Mr. Powell a rebuke from Patrick McHenry, the top Republican on the committee. “Monetary and fiscal policy are two very different things,” Mr. McHenry said. “I would urge you and the leadership of the Fed to stick to monetary policy.”
The heated debate over extending support poses an underappreciated risk to the North American recovery. Investors, in particular, should pay attention.
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