With 2021’s fourth quarter upon us, it’s increasingly clear that what I call a Frankenstein economy is upon us. No, I don’t mean we are dealing with an out-of-control monster that could turn on us and wipe us out, but I do mean that we have an economy sutured together in Washington and other national capitals, mostly in response to COVID, that has unpredictable and unnatural tendencies that make business highly uncertain and therefore subject to large bottom-line changes. Much of the chaos we are dealing with has come from trillions of dollars of printed money that has been injected into consumer and business purses without the corresponding production of goods and services that usually accompanies such cash flows.
For months now, we have awaited the time when the economy would be open again, when travel and tourism would resume, and when the massive levels of funds in checking and savings accounts would begin to be drawn down. That time has now arrived, and we are getting some pretty hot inflation numbers as a result. We now have a textbook situation of too much money chasing too few goods. Second quarter retail sales were up 18 percent over 2019’s final quarter, which was before all this started, and prices and the level of all prices taken together are heading higher.
Results of the COVID Interventions
Some of the odd features of the Frankenstein economy stem from serious 2020 COVID-related interventions. For example, most commercial and some industrial activities deemed to be unessential were shuttered for much of 2020. In other cases, employment was shifted from the workplace to home. This included much of the services economy as well as schools and day-care. As a result, female and lower-income employment were hurt disproportionately, and many people discovered that this time of interruption would be ideal for starting a business.
An explosion of new businesses has occurred across the nation, and lots of people who previously went to work every day won’t be heading back to the office. Meanwhile, a flood of federal money flowing into individual bank accounts has softened the blows that accompanied interrupted life and provided cash to fund home improvements, additions, and even new, larger homes. Put another way, the COVID-Frankenstein economy was biased toward construction activity, which all along was defined as an essential activity.
We know some of the results of all this. Skilled labor for construction has become almost impossible to find. Building material prices have skyrocketed. Some wood and timber products, for a while, simply could not be found. Even paint and appliances are often out of stock, and housing prices for median homes sold have skyrocketed by more than 20 percent.
To put some dimensions on this, the year-over-year all-item consumer price index has increased by more than five percent for July, August, and September, hand-running. The most recent September producer price index (PPI) was up year-over-year over eight percent. Within the all-item PPI, the overall construction component was up 5.2 percent, and the construction equipment component was up 5.4 percent. Going a bit further, we now know that more than 84 percent of the items contained in the most recent Consumer Spending Price Index, which is preferred by the Fed, show price increases. In short, inflation is part and parcel to the economy, and will be with us for the next couple years or even longer if the current full-fledged spending package now being debated in congress gets passed into law.
But why worry so much about inflation? Surely, prices can adjust, and life will continue. That said, we know that high and accelerating inflation robs purchasing power, punishes savers, raises interest rates, which raises the cost of funding the national debt, and all that takes a heavy toll on economic activity. Even worse, higher inflation leads to Fed action to control it, and that generally leads to a recession.
What about the Larger, Local Picture?
Even though we have a stumbling COVID-affected Frankenstein economy, we still have an economy generating strong overall activity. Real GDP growth for 2021, in spite of our difficulties, will likely exceed 5.0 percent; but, with stimulus infusions gone for the most part, 2022’s growth will most like slow to four percent or less. Population growth in the Carolinas, southeastern and western states will continue to outpace growth in other regions, as will most measures of economic activity, including construction as well as manufacturing and services.
Is there a recession in the crystal ball? Not right now, but if this inflation spiral continues, we best fasten our seat belts and get prepared. The Fed seems to be moving its figurative foot away from the accelerator. The brake pedal could be next.
Bruce Yandle is Alumni Distinguished Professor of Economics, Clemson University, and Distinguished Adjunct Fellow with the Mercatus Center at George Mason University where his quarterly Economic Situation Report is posted.