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Steven Fazzari: Brace yourself for some really bad economic news

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Social distancing in response to the coronavirus pandemic, it has quickly become clear, will create severe economic fallout. Large parts of the U.S. economy have almost entirely shut down. New unemployment claims have surged dramatically, dwarfing past records, both nationally and in Missouri.

I’ve analyzed data from several economic sectors most affected by the crisis. In 2018, these sectors totaled 18.5% of aggregate U.S. output (gross domestic product). We don’t yet know how much each will contract, but to roughly calculate the severity of the coming downturn, I estimated each sector’s lost output between mid-March and the worst week of the crisis, which is likely to occur during the second quarter. Contraction estimates range from 20% in wholesale, 40% in retail, and 80% for air transportation, restaurants, entertainment, recreation and hotel accommodation.

While much uncertainty remains, the possible effect on total U.S. gross domestic product is stunning: a drop of nearly 8% in just a few months. An output collapse of this size is unprecedented in modern U.S. economic data. Most economists consider the Great Recession of 2007-09 the worst contraction since the 1930s, but in that crisis, output fell “only” 4% over 18 months. Even if the economic effects of this pandemic are half as large as suggested by my estimates, the coming contraction will be historically severe.

The government reports gross domestic product data for each quarter at an annual rate. Growth for the second quarter of 2020 will be reported as if the economy contracted at the same rate for a full year. With most of the decline concentrated in April and May, I fear an annualized GDP contraction of 15% or more for the second quarter. By comparison, in the fourth quarter of 2008, the worst of quarter of the Great Recession, GDP fell at an annual rate of 8.4%.

Other factors could make things worse. For example, my numbers do not include “multiplier” effects that arise when people lose income, or fear they will lose income, and cut back on spending. Reduced business capital investment will magnify the size of the contraction. Manufacturing is also declining, both because of low sales and to limit workers’ exposure to the coronavirus.

The data looks scary. But a silver lining to the economic cloud could be a quick recovery. We have reason to hope the health threats of the virus will pass in a few months. When things calm down, Americans will want to return to normal life and pent up demand could surge. We can hope the recovery proceeds quickly, perhaps starting as soon as the third quarter. This outcome is not guaranteed, however. The initial wave of economic contraction might trigger further problems that will persist even as the health crisis recedes.

Federal policy can improve chances for a quick bounce back. The Coronavirus Aid, Relief, and Economic Security Act signed by the president on Friday is a step in the right direction. The act enhances unemployment benefits so that, in most states, weekly wages will be replaced up to $800 to $1,000 for the next four months. Unemployed workers in Missouri will receive benefits equal to or greater than their previous wages up to $920 per week.

This policy supports those most affected by the recession, and it reduces multiplier effects. One-time cash payments to most American households will be less effective than enhanced unemployment but will probably lead to modestly higher consumer spending, especially when social distancing requirements ease.

The act also provides new business loans, in some cases partially forgivable. This access to cash will support many businesses that might not survive to participate in the recovery. Americans would not be able to return to restaurants in the summer and fall if a large share of those restaurants have permanently shut down.

So brace yourself. Economic data over the next few months will likely look very bad. It is simply too late for policy to prevent a severe contraction. The focus now must be on quick recovery. The challenge is sizable and requires a sizable federal response. The coronavirus relief act addresses some critical needs but remains more focused on “rescue” than economic “stimulus.”

Additional federal intervention may very well be necessary, and soon.

Steven Fazzari is a professor of economics and sociology at Washington University.

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