To say that 2021 was a strong year for U.S. and global economic growth would be quite an understatement. Coming out of the 2020 COVID-19 recession, growth in 2021 reflected a massive rebound as stimulative fiscal policies and accommodative monetary policies pushed the U.S. economy to post some of the strongest real GDP growth rates in decades. U.S. job gains also rose rapidly in 2021, sending the unemployment rate sharply lower in the wake of COVID-19.
GDP and job growth were not the only data series that surged to its highest levels in decades in 2021. Equity markets, home prices, and consumer inflation also rose sharply. The same stimulative fiscal policies and accommodative monetary policies that supported GDP growth in the wake of COVID-19 increased the amount of money chasing assets and consumables.
The rise in asset values and stock prices encouraged people to spend, as part of a wealth effect. That’s when people feel wealthier, so they spend more. It’s generally good for an economy, but it also pushed prices of consumables higher. And it’s why a lot of inflation has accompanied strong GDP and jobs growth.
Looking ahead at 2022, growth is likely to slow to more “normal” pre-COVID-19 levels reflective of more trend-like dynamics—especially as central banks remove monetary policy accommodation to fight inflation. But there is a risk that policymakers could get it wrong.
Inflation: The bane of central banks
As a mirror of the dynamics in real GDP growth, significant weakness in consumer inflation in 2020 was countered by a massive surge in consumer inflation in 2021. Because of the fiscal and monetary policies implemented during and after the COVID-19 recession, the U.S. economy quickly began running on all cylinders. The problem is it’s like we have been running on eight cylinders, but we only have a six-cylinder economy.
In many ways, recent high inflation is a symptom of an overly strong economy that was essentially foie grased by policies designed to engender a quick rebound from massive recession. Unfortunately, inflation isn’t something that goes away on its own. In fact, if left alone, inflation could go even higher. This is why high commodity, producer and consumer prices are disconcerting for central banks from a policy standpoint.
The solution is for central banks to remove some of their monetary policy accommodation that has been artificially depressing interest rates and boosting business and consumer demand for goods and services. Managing this situation adroitly, however, is a challenge. As the Fed pulls back on the throttle to get our economy down from an overly stressed eight cylinders back to our actual capacity of six, there is a not small risk of activity dropping down to only four.