Now in the fourth quarter of 2021, hope springs eternal that the worst of the coronavirus pandemic is behind us. Labor demand is strong, and economic growth continues. However, expectations earlier in the year for a rapid vaccine-induced recovery have proven overly optimistic, with the resurgent delta variant, rising inflation and fiscal uncertainty dashing early hopes.
“It is likely that the most memorable thing about 2021 will be that it is turning out to be different than what it promised in its onset,” says Mira Farka, associate professor of economics and co-director of the Woods Center for Economic Analysis and Forecasting at Cal State Fullerton’s College of Business and Economics, and Anil Puri, director of the Woods Center and CSUF provost emeritus.
Farka and Puri presented a three-year outlook for the national, California and Orange County economies at an Oct. 20 virtual conference attended by Southland business leaders, academics, policymakers and business students.
The Return of Stagflation? Perhaps It’s Stallflation
Clogged seaports, increasingly lengthy shipping times, shortages of cars and technology. The consumer world in the fall of 2021 isn’t what any of us expected in the high-tech and globalized world of the 21st century.
Older generations will remember the terrors of stagflation, a combination of inflation and simultaneous low economic growth, or even recession that first emerged in the 1970s, much to the surprise of the economists of the time.
In the past four decades, inflation has remained in check, moving the economic calculus to keep growth going and unemployment in check.
But 2021 has seen the return of stagflation to the lexicon of both Wall Street and Main Street.
“To be sure, the chatter has been about a mild case of stagflation rather than the full-blown kind, but as long as it haunts analysis and underscores background risk, its very existence makes for a troubling environment,” say Farka and Puri. “Our view is more sanguine than the grim prognosis of the stagflationary crowd though less cheerful than the Goldilocks economy (high growth/low inflation) that some economists and most policymakers are penciling in. The most pressing and longer-lasting concern is inflation, which much like the virus, will likely become endemic and pervasive, at least over the forecast horizon. That combination — somewhat slower growth and higher inflation, or ‘stallflation’ — though much more unsettling than the buoyant outlook of just a few months ago, is still orders of magnitude better than the dour prospects of an economy mired in stagflation.”
Farka and Puri say the “stallflation” scenario suggests continued growth, though at a slower pace than earlier in 2021, a continued labor market recovery and the uncomfortable side effect of inflation.
Though many market analysts, including the Federal Reserve, and President Joe Biden have emphasized the transitory nature of inflation, chalking it up largely to the reopening of the economy after COVID-19, Farka and Puri believe that dismissing inflation as a short-term quirk is mistaken.
“This inflationary outburst, while featuring some transitory traits, has all the hallmark makings of something more permanent — a more sustained outbreak — at least over the next few years. That’s because it is fueled both by demand and supply side shocks, which will take a while to fully resolve,” they report. “The unleashing of a formidable pent-up demand as consumers reawaken from the pandemic slump is being powered not only by an astounding rise in equity and home values, but also by unprecedented fiscal support.”
Exceptional supply constraints are a significant factor that Puri and Farka see powering the 2021 inflation as well as underpinning slower growth.
“Reopening bottlenecks, clogged ports and pandemic-induced reshuffling of supply chains across the globe have caused businesses to run headlong into shortages of everything: microchips, houses, cars, furniture and appliances. Even labor is in short supply as businesses struggle to lure reluctant workers. Inventory-to-sales ratios have fallen to their lowest level in over 25 years (since records began),” they report.
The COVID-19 Virus: Down But Not Out
While the delta variant surge seems to be in retreat, with lowering levels of new cases and hospitalizations across the U.S., Farka and Puri caution that the economic recovery remains hostage to the coronavirus.
“Putting the past behind you is crucial when moving forward. But what to do when the past simply won’t disappear? The world has grappled with COVID-19 for far too long — a painful 21 months — yet the virus lingers on disrupting lives and economic activity,” Farka and Puri report. “We look forward to a day when the virus is so insignificant that it would only merit a footnote discussion (or nothing at all) in this report and we get back to the humble (and humbling) business of “pure” economic forecasting. Alas, that day is not here yet.”
Part of the problem is vaccine hesitancy in parts of the Western world — especially parts of the United States, but also a slow rollout of vaccines in such critical manufacturing hubs as Southeast Asia. And while vaccines remain the solution to minimize the personal risk of death or hospitalization, the delta variant has presented new challenges, as vaccine efficacy appears to have ebbed somewhat.
Farka and Puri point to Israel’s continued COVID-19 surges, despite being one of the most vaccinated nations on earth, as an example of the continuing headwinds.
“As long as the virus remains with us, lingering concerns about new mutations, their transmissibility and potential ability to evade the vaccines will always remain. Let’s hope these concerns will never materialize,” the economists say.
The Shadow of Debt and Monetary and Fiscal Policy
The latest debt-limit standoff in Congress is a reminder that monetary and fiscal policy in 2021 stand in the shadow of debt, which means combating inflation by raising rates is significantly more complex when debt levels are this high.
“Should inflation expectations become de-anchored, interest rates would need to rise dramatically prompting a bruising recession similar to the early 1980s. But the pain would be much more profound now given the massive amount of public debt. Back then, the ratio of debt-to-GDP was a puny 25%. It has more than quadrupled now, standing at 103%. A one percentage point rise in interest rates translates to roughly an additional $240 billion in interest payments. Should interest rates rise to say, 4% — far below 1980s level — interest on the debt will skyrocket by a jaw-dropping $1 trillion, on top of a current nearly $400 billion. Will the Fed be able to withstand the political pressure and the public outcry that will undoubtedly follow? Something tells us this is one question the Fed fervently wishes it never has to find the answer to,” say Farka and Puri.
The Orange County View: COVID-19 Epilogue?
Looking at the Golden State, Farka and Puri note that California has weathered the delta variant surge better than such hot spots as Florida and Texas, though unemployment remains elevated statewide and in Orange County, thanks to more severe restrictions than in many other parts of the country throughout the duration of the pandemic.
However, widespread vaccination raises hopes that the Southland might experience better conditions in the future than the rest of the nation.
“Given robust vaccination rates in Orange County and Southern California, we expect the recovery in the region to gather more steam than in the rest of the country. Putting the virus behind us is especially important for employment growth, which began to sag during the summer months due to the spread of the delta variant,” they report.
Latest available data (August 2021) reveals a 6% unemployment rate for Orange County and 7.5% for California, significantly above pre-pandemic levels, but much improved from the 14.9% and 16%, respectively, at the height of the pandemic. Orange County specifically still has 93,000 jobs to gain to get back to February 2020 levels.
Looking at the demographics of Orange County according to the 2020 Census, Farka and Puri note a slight decline in population (due to lower immigration, low birth rate and internal out-migration), a highly educated and high-income labor force compared to the rest of the state and nation, and nearly a third of the population being foreign-born residents. Recognizing that demography is destiny, the economists anticipate these trends to be definitional to the Orange County economy of the future.
Despite higher educational attainment and incomes, Orange County residents continue to face persistently unaffordable housing, a trend that has only accelerated during the pandemic.
“It is unquestionable that the pandemic contributed significantly to the recent run-up in home prices. As the economy reopened, it unleashed pent-up demand for housing spurred by unprecedented household savings, generous government giveaways and reduced spending over the past 18 months. Zoning restrictions and building constraints coupled with higher raw material costs have resulted in fewer houses being built, exacerbating one of the tightest housing markets ever. Low mortgage rates for the last several years have stoked demand further. These trends will continue in the near term. However, as supply constraints ease and mortgage rates rise in tandem with anticipated rate hikes, we expect that home price acceleration will wind down substantially over the medium-to-long term,” report Farka and Puri.
With legislation to allow for more housing starts and significant funding to address the issue, Puri and Farka foresee an alleviation — but by no means a resolution — of the region’s homelessness crisis, which is at least partly tied to high housing costs, though also to societal factors such as substance abuse, mental illness and family woes.
According to Farka and Puri, Orange County stands poised to gain, on an annualized basis, 29,300 payroll jobs in 2021, 59,000 in 2022, and 52,700 in 2023. Southern California is expected to gain 116,100 jobs in 2021, 253,000 in 2022 and 204,700 in 2023. Orange County and the Inland Empire are expected to reach their pre-pandemic levels by the end of 2022, but due to slower gains in Los Angeles County, the largest county in the region, the Southern California region may not get there until the middle of 2023.