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Institute sees Congress, Fed actions driving fast recovery

Economists expect economy to rebound in 2021

The Federal Reserve building.
The Federal Reserve building. (Caroline Brehman/CQ Roll Call file photo)

Economists at a Washington think tank are forecasting a sharp downturn because of the COVID-19 pandemic, but then a rapid recovery largely on the strength of “enormous” spending provided by federal economic recovery packages and adroit management by the Federal Reserve.

Citing an “unprecedented expansion of fiscal policy,” Karen Dynan, a former Treasury and Federal Reserve economist, predicted on Friday that U.S. growth will decline by 8 percent in 2020 under the impact of the COVID-19 pandemic but then rebound strongly in 2021 with growth of 10.2 percent.

Dynan, now at the Peterson Institute for International Economics, also credited the Federal Reserve and other central banks with rapid, effective intervention to provide liquidity to the financial sector via asset purchases and swap lines, as well as other actions to free up lending channels that slowed dangerously.

“As a result, we’re going to avoid the kind of financial crisis that we had a dozen years ago, that might have cast this long shadow in terms of depressed economic activity,” Dynan said. “That’s been very heartening.”

Dynan, speaking at the Institute’s global economic prospects event, cited the rapid impact of “very aggressive” fiscal policy, with more than $2 trillion in relief to the health care sector, states, households and businesses that should impact the economy very quickly.

Congress has thus far enacted three laws (PL 116-123, PL 116-127, PL 116-136) with about $2.5 trillion in aid in response to the pandemic, and lawmakers are already working on a fourth. Much of that money is aimed at containing the economic damage as more than 16 million workers have filed initial unemployment claims in the past three weeks.

“More is to come, here and elsewhere,” Dynan said. “I think there are places where policy has not gone far enough. But I’m heartened by what we’ve seen so far, and what I think we’ll see is economic policy stepping up to boost demand such that there will be enough demand when supply comes back on line.”

Adam Posen, president of the institute and a former Fed economist and official at the Bank of England, noted that he and Dynan are more optimistic than many economists. He said that both expect a so called “check-mark” shaped economic recovery, with a steep, sizeable decline in output followed by less steep but equally strong growth over several quarters.

“The amount of fiscal stimulus we’re talking about is enormous,” Posen said. “It’s likely to be very high multiplier, it’s going to be very fast. Full credit to Secretary Mnuchin, Speaker Pelosi and others who made the CARES Act….  Fiscal policy is likely to be extremely effective.” CARES is the acronym for the third rescue package.

Posen also compared the coronavirus fiscal response, some 10 percent of GDP over a few months, favorably to action by the federal government during the financial crisis of 2008-2009, which he estimated at some 3 percent of GDP over a longer period with a “mixed multiplier,” that is, with different categories of spending hitting the economy at different rates.

Dynan said the $2 trillion of spending from the most recent recovery package will be complemented by another $1 trillion of automatic stabilizers, with a possible additional spending package on the way, with more for states, more for small business, more for the unemployed.

She also cited the impact of Fed lending as another factor that will support rapid recovery.

“A decent chunk of the CARES Act goes to, basically, facilitate Fed lending,” Dynan said. “That $450 billion goes to support something like $4 trillion of Fed lending. So even if that doesn’t have as high a multiplier as money that’s going directly to the unemployed, that’s also really going to be helping the economy.”

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