March 29, 2021

HEM: afterglow illusion

The recovery from re-opening will not undo the damage done.

Key views:  

1) Lockdowns will leave a painful legacy, with brisk mechanical rebounds falling far short of full recovery.

2) Fear of vaccine-resistant strains mean activity restrictions remain part of the policy toolkit

3) Monetary policy lacks the power to stimulate activity independently of fiscal policy

4) De-globalisation continues with the populist pursuit of supply chain independence

March 26, 2021
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UK: consumers stop feeling special

  • UK retail sales rebounded by 2.1% m-o-m in Feb-21, as expected, leaving the level about 10% below the Oct-20 peak. GDP has been less sensitive to lockdown this time so won’t bounce by as much, although a 25% recovery of Jan-21’s fall would be good news.
  • Consumers have been shielded from the economic pain of lockdown but in March they stopped assuming that outperformance would extend through the year ahead. Mobility has improved recently but the UK remains among the most depressed in the world.

March 26, 2021

Tenreyro - Response to the Covid-19 pandemic: UK and US experiences

  • "The divergence between labour-market quantities and price inflation had been the source of debate about the slope of the price Phillips curve, the size of the output gap, and the level of full employment."
  • "In the MPC’s February 2021 forecast, UK GDP returned almost to its pre-Covid peak by the end of 2021, a much faster recovery than during the financial crisis. However, by the same point, the median FOMC member now anticipates that US GDP will be 4% above its earlier peak."
  • "the main cause of these vast differences in short-term developments has been the specific policy measures used to mitigate the economic damage from the pandemic in each country."
  • "the extent of scarring is itself likely to depend on both the fiscal and monetary policies in each economy."
  • "It is possible that paying generous unemployment benefits in a flexible labour market and while vacancies were at all-time lows had similar effects as the European furlough schemes did. Moreover, the relatively rapid recovery in US demand means that many workers who were not recalled may have less difficulty in finding new jobs."
  • "US micro evidence suggests that extra savings have been quite equally distributed across households of different income levels, and if anything have been slightly skewed towards lower income groups."
  • "recent survey evidence indicates that only 15% of UK households plan to spend more to catch up on previously unavailable services once the economy reopens, only slightly higher than was the case in January, and smaller than the amount of households who expect to spend less."
  • "The time horizon of the shock is likely to be important in influencing the effect of the policies on scarring. Individual defence – furloughing workers to maintain existing micro structures of employment – may be most likely to prevent scarring when the shock is temporary and does not lead to significant changes to consumer preferences and/or the structure of production. In that case, with less need for reallocation, matches are more likely to be maintained when furlough ends. The structure of the economy may also matter. For example, if labour markets are flexible, then zone defence – that is, providing generous social insurance and protecting household incomes to maintain demand – may enable employment to recover quickly, with less risk of scarring as a result."
  • "a key influence on the outlook will be the extension of the furlough scheme until the end of the third quarter, when all UK adults are expected to have been offered a vaccine. This has implications for demand, since it lowers the risk of a sharp rise in unemployment when the scheme ends. It also matters for supply, by reducing the risk of labour-market hysteresis. Recent expansionary US fiscal policy will also be important for the UK outlook."
  • "Despite the fiscal policy differences, I do not see a major divergence in long-term inflation risks across countries: monetary policymakers have the tools to contain and manage those risks, and would not hesitate to use them. All else equal, the greater fiscal boost in the US is likely to lead to a faster rise in the equilibrium rate of interest, r*, than in the UK."
  • "I would not consider a pick-up in inflation to be sustainable if it was due to transitory one-off effects, which are likely given recent rises in energy prices, as well as base effects from sharp falls in inflation at the onset of the pandemic. Moreover, it is possible that short-run supply could be somewhat constrained owing to production bottlenecks as the economy recovers, while current fiscal plans will lead to stronger demand in the near term, with weaker demand in future years. To the extent that these effects prove temporary, they would not imply any sustained pick-up in excess demand, nor in inflation, provided inflation expectations remain anchored."
  • "Despite lessening downside risks, there also remain a number of scenarios that I would anticipate requiring looser policy later this year... A delay or reversal in the relaxation of health restrictions, or renewed caution from households and businesses, would require more monetary support to help them bridge across to a period when health risks had been reduced. As always, the required loosening in monetary policy would also depend on the response of fiscal policy to any renewed economic weakness."