Investors and economists are growing concerned about the potential impact of the highly transmissible delta variant of COVID-19. The recent drop in retail sales, decline in consumer confidence and heightened market volatility suggest a slackening in the pace of the U.S. economic recovery. Previously rosy projections of GDP growth during the third quarter of 2021 will need to be reconsidered in light of recent developments.
Despite growing downside risks, the likelihood of a return to lockdowns (which could derail the U.S. economic recovery) is quite small. Once the virus spread peaks in the next few weeks and then gradually abates, it is likely that the economy will regain its momentum and some of the activity that was slated to take place in the third quarter will end up being shifted to the fourth quarter, thus boosting year-end growth.
Even as vaccines exhibit reduced efficacy against the delta variant, and despite a general waning in vaccine effectiveness over time, it is critical to note that they are still able to lower the odds of hospitalization, prevent serious illness and dramatically reduce mortality risks. Fear of the delta variant has boosted vaccination rates of late. The Biden administration’s push for a booster shot, though controversial, should offer U.S. residents additional protection.
Furthermore, the overall economic impact of each successive wave of the COVID-19 outbreak has lessened as both employers and workers in the U.S. have learned to adapt to the pandemic. In places like the U.S. and UK, there is a growing realization that we need to learn to live with the coronavirus. The Atlantic’s Sarah Zhang recently observed: “When enough people have gained some immunity through either vaccination or infection – preferably vaccination – the coronavirus will transition to what epidemiologists call ‘endemic.’ It won’t be eliminated, but it won’t upend our lives anymore.”
Highly accommodative monetary policy and unprecedented levels of fiscal stimulus will continue to support the recovery. It is worth noting that even as the impact of household stimulus checks and enhanced unemployment benefits start to wane, the recently introduced child tax credit program will aid millions of Americans. Passage of the bipartisan infrastructure bill will offer additional economic stimulus. Moreover, state and local governments have yet to deploy a significant fraction of their already allocated federal funds.
A key driver of economic optimism is the fact that U.S. household consumption is expected to remain robust for the foreseeable future. High levels of saving and elevated real estate and financial asset values imply a healthy household balance sheet. Tight labor market conditions are pushing up nominal wages sharply and providing a boost to low-income households. Surging inflation does pose a threat as it may curtail spending power if real wages decline.
A notable downside risk is the continuing threat posed by intermittent global supply chain shocks and resultant spikes in inflation. The most important cog in the global manufacturing supply chain – the Asia-Pacific region – continues to struggle with low vaccination rates. East and South East Asia, Australia and New Zealand are overly reliant on a flawed and unrealistic containment strategy that is focused on eliminating the virus (the zero-COVID approach) through the imposition of draconian lockdowns, strict border controls and extreme quarantine measures. Such strategies may have been appropriate in the early days of the pandemic prior to the discovery of effective vaccines. Nowadays, they are not just massively disruptive but also exorbitantly costly.
The fragility of the global economy was highlighted by the recent partial shutdown of the world’s third busiest port in China (due to a single COVID case) that snarled global supply chains. Semiconductor shortages have already hurt global auto production and led to a dramatic upswing in car prices. The impact of fresh lockdowns in the Asia-Pacific region is going to reverberate throughout the global economy and pose a risk even to the U.S. economy.
Boosting global vaccination rates is the single most effective policy response to both the health crisis and the economic problems afflicting much of the world. Otherwise, we may be headed for a bifurcated recovery in which Europe and North America continue their ongoing economic resurgence on the back of high levels of vaccination while the rest of the world continues to struggle.
From a U.S. standpoint, continuing to stick with policies that have outlived their usefulness is another potential risk. Extending enhanced unemployment insurance beyond the September expiration date may further distort the labor market and limit the pace of the economic recovery.
On the monetary policy front, the continuation of the Federal Reserve’s asset purchase programs is increasingly hard to justify. Boston Fed President Eric Rosengren recently noted that the downside risks associated with the Fed’s quantitative easing measures may now be starting to outweigh any upside benefits.
As it stands, the delta variant poses a serious health risk to the unvaccinated and is poised to add additional pressure on the U.S. health care system. But from a macroeconomic standpoint, the impact of the latest virus surge on the U.S. economy should be quite modest. As long as the labor market continues its rapid recovery and consumer spending stays strong, the U.S. economy will remain on track to achieve a full-year GDP growth rate of around 6 to 6.5 percent (the highest since 1983).
The delta variant does, however, pose a bigger threat to the under vaccinated parts of the global economy. And it also raises the risk of a potential upside surprise on the inflation front.
Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.