Economic growth is forecast to bounce back in the short-run, but measures of consumer sentiment have yet to reflect such optimism in the ongoing recovery. Additionally, longer term prospects appear to show continually rising levels of federal debt and inflation, along with lower levels of GDP growth. That combined outlook of economists and consumers is starting to create a familiar mix that could lead to a new round of stagflation in the coming years.
The short-term economic outlook is beginning to improve, despite a more pessimistic longer-term picture.
Perhaps the best news is that new cases of COVID-19 around the world have been plunging in recent weeks. The drop has been particularly pronounced in the US where, as of February 25, the 5-day moving average of new cases was just about 67,100. That is down 75% from January’s peak of more than 263,800.
It is not totally clear why the downturn has accelerated so quickly, but various observers have their own points of view. Most seem to believe that it is a rising rate of vaccination, as well as adherence to government guidelines about masks, social distancing, and staying at home – but even in places where such restrictions have been limited, such as Florida, cases are plunging as well.Whatever the reason, the trend is undeniable, and it suggests economy may be entering a sweet spot over the next couple of quarters. Real growth will be surging as it did in the third quarter of last year; inflation, meanwhile, is likely to remain subdued for another few months in a lagged response to demand suppression during the lockdowns.
However, there is good reason to believe that a period of higher growth and subdued inflation may be short-lived.
The most recent University of Michigan survey of consumer expectations clearly shows a gradual creep up in expectations toward higher inflation and lower growth. In other words, a creep towards stagflation.
According to the UMich data, inflation is expected to rise to 3.3% over the next 12 months, the highest reading since 2014. Meanwhile, consumer sentiment has gradually deteriorated since autumn.
It’s not just everyday consumers who are thinking about this scenario. Economists at the Congressional Budget Office (CBO) recently issued a 10-year forecast, noting that inflation is expected to remain low while the economy recovers from the COVID crash. In the latter part of the decade, however, growth slumps to below average rates while inflation is consistently well above the Fed’s 2% target.
Annual GDP growth is expected to jump to 4.6% in 2021, up from -3.5% in the previous year. In 2022, however, growth will drop off to 2.9% and progressively decline down to an annual average of 1.7% between 2026 – 2031.
Several key measures of inflation, meanwhile, are expected to continue a steady climb toward levels above 2% per year.
That inflationary pressure will be fueled by large deficits over the next 10 years, expected to total $12.6 trillion. Though that is less than the last time they issued their outlook for the next decade last September, it will push federal debt as a share of GDP to 103.2% by the end of the 2020s.
The Wall Street Journal recently noted that, as a share of economic output, the deficit is projected to be 10.3% in FY 2021, the second-largest shortfall since the end of World War II, surpassed only by…