What comes after the stimulus-fueled short-term economic boom?

Economists are tripping over each other in a race to upgrade their forecasts for U.S. GDP growth. Even the normally staid Organization for Economic Cooperation and Development (OECD) upped its GDP growth forecast for the U.S. to 6.5 percent in 2021. Others are even more optimistic, and if their projections were to be realized, it would mark the fastest annual economic growth rate attained by the U.S. since 1984. Some have even suggested that this may be the beginning of a new and more optimistic economic era.

Assuming that the rapid vaccine rollout continues, a consumer spending binge is expected to be unleashed this summer. Short-term tailwinds generated by unprecedented levels of government stimulus are expected to stoke pent-up demand and create an economic boom. Economists at Goldman Sachs forecast a sharp decline in the U.S. unemployment rate by the end of 2021. Stock markets have further room to run and will likely set fresh records this spring. Clearly, the near-term prospects for the U.S. economy appear very bright.

There are, however, a few serious headwinds that are likely to pose a threat to the U.S. economy, especially over the medium to long run. In the near term, the biggest threat may arise from an unexpectedly sharp spike in average price levels, which may potentially generate higher inflation expectations. If the Federal Reserve decides to downplay the inflation threat and sticks to its commitment not to tighten monetary conditions until 2024, then, as noted by Olivier Blanchard, the central bank runs the risk of either letting inflation expectations become unmoored, or, in a belated effort to rein in surging inflation, being forced to sharply tighten policy rates.

In light of ongoing investment frenzy and market mania in pockets of the financial world, a sudden spike in market rates would inevitably create financial turmoil. The roaring housing market may also be adversely affected, which has the potential to create real pain for the broader economy.

The enormous non-financial corporate debt pile and surging public debt levels pose a longer-term threat to the U.S. economy. China’s experience in the aftermath of the global financial crisis offers a cautionary tale. In 2009, China unleashed one of the biggest stimulus programs in modern history, which, after enabling a rapid post-global financial crisis recovery, left a massive debt overhang and a severely distorted economy. A sharp economic slowdown and a stock market meltdown was the end result.

Even prior to the pandemic shock, U.S. non-financial corporate debt had reached record levels. The pandemic forced many American corporations to load up on even more debt. Economists are fearful that high levels of indebtedness may negatively affect the performance of the corporate sector in the coming years.

U.S. public debt has also exploded in recent years. Trump-era tax cuts and government expenditure boosts meant that the U.S. was already running a trillion-dollar budget deficit in 2019. The pandemic created a need for substantial fiscal intervention, which led to an unprecedented peacetime increase in both budget deficits and public debt levels. A persistent dilemma is that neither of the two main parties have shown the political fortitude necessary to improve fiscal balances during good times so as to be prepared to undertake much-needed stimulus measures during bad times (a key feature of Keynesian economics that is notable for the extent to which it is widely ignored by policymakers).

The historical role of the U.S. dollar as the pre-eminent global reserve currency has allowed the federal government to ignore fiscal restraints for decades. There is, however, a growing realization in the international financial community that profligate spending and rising debt burden may force the U.S. to engage in gradual currency debasement in the coming decades. Even domestically, there is a growing chorus of calls for the U.S. to abandon its official strong dollar policy, an action that might speed up the search for reserve currency alternatives, especially of the digital variety. Strong foreign demand for U.S. Treasuries may prove to be a casualty of such a development.

The expected burden of caring for an aging population will impose additional constraints on the federal budget in the coming decades. Instead of providing much needed funds for upgrading infrastructure, research in basic science and improving the quality of public education, much of federal budgetary resources are increasingly devoted to various transfer programs. In order to avoid intergenerational conflict regarding the bloated public debt, letting inflation run higher for longer may be a necessary step (which also implies a weaker dollar over the long run). 

Finally, the pandemic shock’s impact on underlying drivers of inequality is also a source of lingering concern. In particular, the pandemic has sped up the trend towards automation and boosted the pace of deployment of Artificial Intelligence (AI). These technologies are skill-biased (they enhance the productivity of high-skilled workers even as they replace less-skilled jobs). It is unclear whether AI and automation will create a sufficient set of new and high-paying jobs. Past concerns regarding technological unemployment proved to be largely unfounded. However, AI’s ability to displace white-collar jobs in the professional services sector may generate significant labor market dislocation over the next decade and further exacerbate inequality.

Even as we look forward to an early end to the pandemic and get ready for a rapid economic recovery, it is wise to keep in mind that longer term challenges still remain and need to be addressed.

Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.