In his newsletter, Bloomberg’s Joe Weisenthal notes that this recession is weird in certain ways. It’s not just the surprisingly buoyant stock market, with the S&P 500 recovering more than half its losses from the trough in March and the Nasdaq Composite actually up for the year. He points out, for example, that the Chainsmokers are raising a venture-capital fund. That’s the sort of thing that typically happens at the frothiest part of an expansion, not during a severe recession. People are also buying a lot of RVs, which is a weird thing to do if you’re worried you’re going to lose a lot of income for a long time. A lot of people aren’t just saying they think everything is going to be okay, they’re putting their money where their mouth is. Why are they doing that?
This observation is closely related to one from the economist Jason Furman, who wants to contest the idea that the recent decline in economic activity is mostly due to a negative shock to demand. A demand shock was the dominant feature of the 2008 financial crisis: Consumers who had borrowed against their homes suddenly lost huge fractions of their wealth when home prices collapsed, and had to cut back their expenses to repair their balance sheets. Those cutbacks in spending had negative effects that spread through the economy, as businesses failed and workers lost jobs due to reduced consumer spending, thus needing to further reduce their own spending. Foreclosures destroyed more wealth and further impaired consumer spending. And the federal government’s fiscal response proved inadequate to offset the shock to demand, which is part of why the recovery took so long. A lot of people are afraid we will be in for a repeat of that experience if the epidemiological conditions do not materially improve very soon.
But a recession can also be caused by a supply shock, in which goods or services become much more expensive or less available. The classic example is the oil crisis of the 1970s. Normally, you would expect prices to go up due to a supply shock and down due to a demand shock, and since the Consumer Price Index fell sharply in April, you might assume this recession is primarily driven by a demand shock. But Furman contests that claim, noting the CPI is facing the opposite of the usual problems with calculating inflation. Usually, you would worry that CPI overstates inflation because it doesn’t account well for new and improving products. But right now, products and services are disappearing or getting worse. Has demand for air travel collapsed or has the supply of air travel to destinations where you can do fun or useful things and that does not come with an unreasonable risk of illness collapsed? A lot of consumers would probably be willing to pay way above the regular price for a normal flight to a normal vacation destination right now, but that product doesn’t exist. If the CPI had proper hedonic adjustments — if it, for example, adjusted the drop in airfares to account for the fact that flying is way less pleasant and less useful than usual right now — it might well show positive inflation, allowing us to identify a supply shock from the sudden impossibility of certain kinds of economic activity like leisure travel.
Negative supply shocks are bad for the economy. But if you believe the supply shock will reverse itself in pretty short order — that much of normal life will resume in a few months, that it will be possible to fly to Cancun next winter and party on the beach — then you might be able to tell a better story about the economic outlook than you could if the recession were driven by a demand shock.
Of course, there are reasons to think there would be a demand shock right now. Tens of millions of people have been put out of work. Even people who are working have good reasons to worry about their future income — whether they might lose their jobs in the future or whether their businesses might fail. So you would expect people to be less inclined to spend, reducing aggregate demand. On the other hand, the government has reacted forcefully to offset the demand shock with deficit spending. The CARES Act provides over $2 trillion to support demand through programs like tax rebate checks, greatly enhanced unemployment benefits, and forgivable payroll-support loans to businesses. Less discussed than the CARES Act’s large size is its speed: While the 2009 stimulus law spread $800 billion in spending over three years, the CARES Act heavily concentrates its spending in the second and third quarters of this year, boosting the overall fiscal response to about 30 percent of GDP during those quarters. This is a huge stimulus, quite possibly huge enough to offset the demand shock the pandemic would have caused absent a fiscal-policy response. And if the stimulus has been large enough, you still wouldn’t see it show up in prices right now. To some extent, consumers are shifting their spending away from unavailable categories to available ones (thus the RV boom), but mostly they may be saving now to spend later, when the goods and services they want become available again. That behavior shouldn’t boost prices today.
Another thing that separates this recession from past recessions is that many households may come out of it with stronger balance sheets than they went in. The 2008 crisis started with a negative shock to balance sheets, which caused spending to contract. Here, the recession started with a contraction in spending, even in households whose capacity to spend has not been impaired. In many households, workers are still employed, collecting all or most of their pre-recession income but spending quite a bit less. In others, workers have lost their jobs but are collecting unemployment checks that in many cases exceed their prior labor income and are spending less. They have also gotten stimulus checks. How often these odd phenomena will lead to household balance sheet improvement will depend on the course of the crisis: The enhanced unemployment benefits extend only through July, and if the employment crisis persists far beyond them but Congress does not extend them in similar form, the share of households that stand to come out ahead will shrink and shrink and shrink. But the CARES Act may prove to be macroeconomically sufficient to support aggregate demand even as millions of households face severe financial distress because others will come out of the crisis more able to spend than they went in. The fiscal response could also prove macroeconomically sufficient because of future legislation increasing its size. This is different from the 2008 crisis, where the macroeconomic response was conclusively insufficient and hardly any households improved their balance sheets.
The stock market zoomed on Monday in response to very preliminary positive news about a vaccine because the economic story that can be told here is so sensitive to the timing of an effective medical intervention to address the coronavirus. The longer the crisis persists, the more businesses will fail and the more jobs will be lost permanently. Even if what we are seeing now is primarily a supply shock, it will beget a major demand shock if it goes on long enough. (This is why Furman wants to be very clear that he supports further fiscal stimulus even though he sees the contraction of economic activity as primarily due to a supply shock.) But I want to note something about the vaccine timing: The arrival of a successful vaccine should act very quickly on the economic outlook even if it can’t be distributed to most Americans for months or a year after approval. The arrival of a vaccine today wouldn’t make music festivals possible tomorrow, but it would make business investments in music festivals much more attractive tomorrow. Businesses and households would gain confidence immediately about the outlook a few months to a year out, which would make them less hesitant to hire and spend today, and that in turn would immediately boost demand for the products and services that are available.
It’s not that investors think everything is going to be fine. The broad stock market indexes — unlike the NASDAQ, which is heavily focused on the tech sector — are down about 10 percent this year, reflecting investors’ view that the outlook for corporate profits has materially worsened. That 10 percent figure understates the true bearishness of the market, since interest rates have fallen sharply and lower interest rates should ordinarily tend to push stock prices up. And that pricing includes a distribution of risk; it is possible that the epidemiological outcomes will be worse than investors are expecting, knocking the recovery off the track they expect, in which case stock prices will fall again. But I think the above explains how investors — and RV buyers — can have an economic outlook that is so sanguine in the face of a pandemic that has shut down so much of the economy.
