A glance at the latest economic data, conveniently summarized using the Citi US Exploding Surprise Index, should be enough to convince most that the US is following a V-shaped recovery path well and truly.
Alas, nothing could be further from the truth, because the current economic sugar fever is almost entirely dependent on a huge increase in government spending, which will be effectively completed in a month. As a result, according to Bank of America, the economy is facing financial cliffs that could lead to a breakdown of recovery, with four specific areas of focus:
- expiration of extended unemployment insurance,
- fading support from incentive checks,
- exhaustion of PPP
- stress from state and local government assistance.
In response, BofA expects that another incentive bill will be passed at the end of July, which will solve some, but not all, of these problems, and “instead of a cliff, we are likely to face a hill.” This may be optimistic, because any incentive should be bipartisan, and if Democrats want to break the chances of Trump’s re-election, now is the time to push the economy into a depression with elections in just 4 months.
Will they do it? We will find out in a few weeks, and, of course, as soon as July 31 will benefit the cliffs.
Until then, here’s a BofA on the likely results of a fiscal cliff:
Fiscal: see below
Amid the shock caused by the COVID-19 pandemic, the fiscal stimulus spilled over into the economy. Washington put forward about $ 2.8 trillion of stimulus, representing 13% of GDP, while the Fed expanded its balance sheet to $ 7.1 trillion. Rapid and determined support on the political front likely limited the recession during the recession and helped support the ongoing recovery. But now we are approaching several “rocks” that will turn out to be painful if measures are not taken. We see four problem areas:
- Unemployment Insurance (UI): The extra $ 600 / week expires July 31. To put some numbers around this, at the current level of nearly 20 million people receiving unemployment insurance this would mean a $ 48 billion reduction in personal income ($ 576 billion year on year) or 2.7% of GDP.
- Incentive checks no longer apply: Most tax credits / checks were distributed in mid / late April. To date, about $ 270 billion out of $ 290 billion has been pumped. We see that consumers quickly spent extra money, which means reduced support costs.
- Payroll Protection Program (PPP): of the $ 670 billion allocated to PPPs, about 77% were approved. The new legislation allows small enterprises to allocate funds before the end of the year (compared to the end of June earlier), which extends the support from the program. However, the scale of support is declining, given that the size of the program has not changed, and it was originally designed to help small enterprises survive the shock, which lasted about two months.
- State and local assistance: The CARES Act has allocated $ 150 billion to states and local governments for unforeseen expenses associated with coronavirus. But this did not concern the shock of revenues of the state and local authorities. According to the National State Legislature Conference (NCSL), 29 states and the District of Columbia are expecting 20 FYE total fund revenues to be lower than their forecasts before COVID. Without help, these governments will be forced to make further cuts in employment and services.
In table 1, BofA groups incentive programs to date in major sectors. About 23% of the funds were directed to households to offset the significant burden on household income as a result of massive job cuts. Moreover, if you include the required part of salary in PPP loans, the share of incentives in the household will be more than 40% of the funds.
The good news is that these measures have worked. Personal incomes in April increased by 10.5%. The annual decrease in compensation by $ 879 billion was offset by an increase in transfer payments by $ 2.999 billion, of which $ 361 billion was in unemployment insurance. Given that PPP started in April, BofA suggests that in April it had a negligible impact on labor income. If incentive checks and unemployment insurance were to be prevented, personal income would have decreased by 5.6% in April from the 10.5% reported.
In accordance with the expectations and the disappearance of the fiscal impulse, last Friday we observed a significant decrease in personal income, given that the growth from incentive inspections decreased significantly compared to April. In anticipation of June, BofA expects another drop in income, as people return to the labor market due to unemployment insurance. Taking into account that the majority of people receiving unemployment insurance earned more than when they worked, the transition to work would actually be a net negative for the total income. Indeed, a recent article (Ganong et al. 2020) showed that approximately two-thirds of UI recipients earn more than their lost wages.
The big question is what happens in August?
This will be the first month following the “cliff”. Current law requires an additional $ 600 per week to expire. Based on the BofA forecast for the labor market, the number of ongoing claims in August could be about 16 million, which is almost 15 million more than before the February levels before COVID. If we assume that it is $ 16 million, then a loss of benefits of $ 600 / week will lead to a drop in income by about $ 36 billion in August or a decrease of 2.3% per month.
The Wage Protection Program (PPP) also reinforces labor income. The Small Business Administration (SBA) approved PPP loans worth $ 516 billion. According to previous rules, 75% of these funds had to go to the payroll during an 8-week period in order to get a loan. Thus, this will mean $ 387 billion. US to support labor income, mainly in May and June. Since then, the law has been amended, so that enterprises need to use only 60% of their funds to pay wages over a 24-week period. However, no changes have been made to the maximum loan amount, which is less than $ 10 million. US or 2.5x average monthly salary in 2019. While changes will help enterprises stay afloat as they cope with declining demand, it also means that support for labor income has been significantly reduced and widespread.
From income to expenses
Obviously, there was a significant increase in personal income from incentives. But now it’s time to consider how this filters out the real economy through consumer spending. The biggest impetus for spending probably came from checking incentives. A Chicago Fed document (Karger et al. 2020) found that two weeks after households received an incentive check, they spent about 48% of this. Then expenses fell to normal levels. Based on an analysis of the aggregated BAC data, the bank also found that Most of the additional costs of incentive testing occurred within 5 days after receiving the money.
Meanwhile, the path of unemployment insurance will affect the path of consumer spending. A document from the Ganong states that spending on durable goods fell by less than 1% when people got the interface, but with exhaustion fell by 12%. Refusal to extend the program will lead to a decrease in personal income by 2.3% in August. Given the high propensity to consume due to unemployment insurance, this will be a similar amount of consumer spending in August.
However, as the program expands, unemployment is also likely to be more severe, as people have an incentive to stay out of work. Indeed, a recent CBO analysis showed that if the program was extended until the end of the year, then 5 out of 6 recipients would earn more on unemployment than if they returned to work. According to their estimates, although this may increase GDP this year, it will slow down growth next year. If instead the program were allowed to expire, presumably the unemployment rate would fall faster and more people would return to work. However, even with more active participation in the labor market, income will still fall, given that unemployment insurance is more generous, and many workers will find it difficult to return to the workforce.
Condition and local stress
In addition to the impending drop-off for household incomes, many state and local governments are faced with the prospect of income as they approach the start of fiscal year 2021. According to CBPP (Center for Budget and Policy Priorities), initial estimates of the impact of revenue from COVID shock indicate that Government revenue may decline in fiscal year 2021 more than during the Great Recession. States will be forced to use their rainy day funds before ultimately cutting spending to compensate for the revenue gap, as they are required to balance their budgets. Indeed, governors in Ohio, New Jersey and Georgia have already asked government agencies to prepare for significant cost reductions. Indeed, state and local governments have already begun to cut jobs – in the April and May employment report, state and local governments laid off nearly 1.6 million people.
Congress will take action in late July / early August
Republicans and Democrats disagree on whether to expand the expanded unemployment insurance program for obvious reasons. Democrats in Congress generally advocate a full extension, as was the case in the Heroes Act, but Republicans resist, arguing that the program’s generosity is hindering a return to work. The average level may be a smaller amount in dollars (possibly $ 250-300 per week) with bonuses for work, which will create an incentive to return to the workforce.
With regard to state and local aid, the HEROES law provides for assistance in the amount of about 1 trillion. Although this number is unlikely, in our opinion, a bipartisan bill proposed by Senator Cassidy (R-LA) and Senator Menendez (R-NJ), proposed in May, will provide $ 500 billion to help state and local governments. The final number is likely to be closer to this number than the sum from the act of Heroes.
There was also some talk about another round of incentive checks with President Trump claiming “Yes, we” [going to do another stimulus check]White House economic adviser Larry Kudlow said the second round is likely to happen, but will be more focused. Although it also showed up in the Dema Heroes Act, some Republicans in the Senate (Senator Tumi (R-PA) and Senator Kornin (R-TX)) recently spoke out against another round. Republicans tend to be concerned that incentive testing is not the most effective way of targeting those who are most in need.
The White House also calls for other measures, such as lowering the payroll tax and infrastructure package, although none of them is unlikely, as lowering the payroll tax will only help those who still have work, while the infrastructure bill is unlikely whether it will be decided before after the election.
Thus, after July 31, the US economy should fly out of the financial cliff, which can be as painful as what happened at the end of March / April, unless a bipartisan agreement on additional trillions of financial incentives is signed in Congress. The clock is ticking now.