At the beginning of 2020, the U.S. economy was in the midst of the longest recovery in American history. Yet towards the latter part of the first quarter, the U.S. economy experienced an exogenous shock from the 2019 novel coronavirus (COVID-19) pandemic and the extraordinary measures taken to respond to it. These policies, which include social distancing requirements and mandated business closures, have reduced the spread of the virus but have also triggered a sudden, sharp decline in economic activity: according to the advance estimate, real GDP declined by 4.8 percent at an annual rate in the first quarter, after three consecutive quarters of growth in the range of 2.0 to 2.1 percent.
Prior to the pandemic, the U.S. economy was performing very well. Data releases portrayed a still-expanding economy, and private forecasters expected GDP growth around 2 percent for the next few years. During the first two months of 2020, the economy generated 245,000 payroll jobs per month on average, significantly above the average monthly paces in the previous two years and well above estimates of the job growth needed to maintain a historically low unemployment rate. The economy’s strength early in the year was also evident in rising household incomes and healthy balance sheets, solid personal consumption, measures of consumer mood approaching the multi-years peaks achieved in 2018, and a marked recovery in the housing sector.
During the pandemic, the United States has responded swiftly and decisively to mitigate its effects on individuals and the economy, implementing expansionary fiscal as well as monetary policies. The Administration’s response includes an unprecedented level of fiscal stimulus of roughly $2.7 trillion. A major feature of the response, the Paycheck Protection Program (PPP), helps small businesses keep their workers on payroll and will protect 60 million to 65 million jobs, or about 45 to 50 percent of private-sector jobs before the pandemic.
GDP Growth
The expansion marked a record 128 months as of February 2020, but the economy contracted sharply in the latter half of March, largely due to the consequences of the COVID-19 pandemic. Real GDP dropped 4.8 percent at an annual rate in the first quarter, reflecting steep pull-backs in personal consumption as well as business investment. The decline in real GDP followed growth of 2.1 percent in the fourth quarter. Private domestic final purchases – the sum of personal consumption, business fixed investment, and residential investment – fell 6.6 percent in the first quarter as lower consumption and business investment outweighed growth in residential investment; this measure of demand rose by 1.3 percent in the fourth quarter.
Stay-at-home orders, which forced many brick-and-mortar stores to close, were implemented in mid-March, severely dampening purchases of services and durable goods. Real consumer spending dropped 7.6 percent in the first quarter, after growing by 1.8 percent in the fourth quarter. Purchases of durable goods, a category that includes motor vehicles, declined 16.1 percent in the first quarter, swinging sharply from the 2.8 percent gain in the previous quarter. Expenditures on services fell 10.2 percent, reflecting significantly reduced demand for travel and lodging, cinemas, theaters, concerts, bars, and restaurants as well as the postponement of non-critical health procedures until after the pandemic. Expenditures on services had added 1.1 percentage points to GDP growth in the fourth quarter, but in the first quarter, this component alone posed a drag of 5.0 percentage points. Despite double-digit declines in purchases of both services and durable goods, consumption of non-durable goods grew by 6.9 percent in the first quarter – a notable reversal from the 0.6 percent decline in the fourth quarter and partially a product of the switch from restaurant meals to purchases of food and beverages for off-premises consumption. On balance, real personal consumption expenditures in Q1 subtracted 5.3 percentage points from growth, posing the largest drag of any GDP component, after adding 1.2 percentage points to growth in the fourth quarter.
Total business fixed investment has constrained GDP growth in each of the past four quarters. In the first quarter of this year, business investment was down 8.6 percent at an annual rate, after declining 2.4 percent in the fourth quarter of 2019. Equipment investment plunged 15.2 percent, partly reflecting less investment in transportation equipment as Boeing halted production of the 737 MAX in January, extending the fourth quarter’s 4.3 percent decline. Spending on structures was down 9.7 percent, reflecting a pullback in manufacturing plants and commercial and health care buildings, after falling 7.2 percent in the previous quarter. Meanwhile, growth of expenditures on intellectual property products, an important ingredient for innovation and future economic growth, increased 0.4 percent, after rising 2.8 percent in the fourth quarter. However, estimated growth could be significantly revised in the second estimate of Q1 GDP, when revenue data replaces judgmental trends for estimates of intellectual property products. Overall, business fixed investment subtracted 1.2 percentage points from real GDP growth in the first quarter.
The change in private inventories, a volatile component, subtracted 0.5 percentage point from economic growth in the first quarter, after subtracting 1.0 percentage points in the final quarter of 2019.
The improvement in residential investment activity during the latter half of 2019 paved the way for a strong burst of activity in the first quarter, despite a significant pull-back in March. Residential investment surged 21.0 percent in the first quarter, extending gains of 4.6 percent and 6.5 percent in last year’s third and fourth quarters, respectively. This component added 0.7 percentage point to GDP in the first quarter, its largest contribution to growth since the second quarter of 2004. However, the economic effects of the COVID-19 pandemic began to weigh heavily on the housing sector in March. Existing home sales, which account for 90 percent of all home sales, declined 8.5 percent in March, after reaching a 13-year high February. Even so, existing home sales were still 0.8 percent higher over the past year. New single-family home sales dropped 15.4 percent in March, falling further below January’s 12-year high, and were 9.5 percent lower than a year ago. Total housing starts, as well as total permits, dropped sharply in March. In April, the National Association of Home Builder’s home builder confidence index plunged to its lowest level since June 2012. Housing affordability has stabilized, as home price growth remains relatively subdued and mortgage rates have declined. Average rates for 30-year mortgages are now more than 1½ percentage points below levels in mid-November 2018.
Government spending increased 0.7 percent in the first quarter, following growth of 2.5 percent in the previous quarter. State and local outlays edged up 0.1 percent while federal spending rose 1.7 percent. However, the contribution from federal government consumption and investment does not reflect the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act was passed at the end of March, but money is being disbursed in the second quarter. Overall, government spending added 0.1 percentage point to growth in the first quarter, after contributing 0.4 percentage point in the fourth quarter.
The net export deficit declined $83.3 billion during the first quarter to $817.4 billion, as exports declined by 8.7 percent and imports plunged by 15.3 percent. The narrowing of the trade deficit added 1.30 percentage points to Q1 GDP growth, after contributing 1.51 percentage points to economic growth in Q4.
Labor Markets and Wages
During the first two months of 2020, the economy generated 245,000 payroll jobs on average per month, accelerating noticeably from the monthly averages in 2018 and 2019 of 193,000 and 178,000, respectively. The economy’s sudden turn, however, resulted in a loss of 701,000 jobs by the time the employment survey was conducted in mid-March. After ending 2019 at a half-century low of 3.5 percent and remaining near that level in January and February, the unemployment rate rose to 4.4 percent in March and may have jumped higher if the labor survey week had coincided with social distancing measures. The labor force participation rates declined 0.7 percentage point to 62.7 percent, declining from January and February’s six-year high.
A measure of labor market health that has come into sharper focus is unemployment insurance claims. Initial and continuing claims were among the first indicators to reflect the effects of COVID-19-related closures of businesses in certain sectors of the economy. Due to COVID-19, they have risen to unprecedented levels, with 30 million workers having initiated claims to unemployment insurance benefits from Sunday, March 15, through Saturday, April 25. Given the high level of claims in April, the official unemployment rate could rise temporarily to the highest level in the post-World War II era. However, while weekly claims remain at high levels, new claims have tapered in the last four weeks, a trend that should continue as the CARES Act is fully implemented and as the health crisis resolves. Both facilitate people returning to work and the economy recovering. The employment report for April 2020 will be released this Friday, May 8.
Prices
Deflationary pressures arose in March due to COVID-19 and other global events. A glut of oil, arising initially from decreased demand due to the pandemic but compounded by the lapse of a production-cut agreement among major oil producing economies, caused energy prices to plunge in March. The Consumer Price Index (CPI) for all items decreased 0.4 percent, largely reflecting the 5.8 percent drop in prices for domestic energy commodities and services. As a result, year-over-year inflation began to slow after picking up earlier in 2020. Over the 12 months through March, the CPI for all items rose 1.5 percent, below the 1.9 percent pace a year earlier. Energy prices fell 5.7 percent over the year through March, after declining 0.4 percent over the year-earlier period. Food price inflation has slowed modestly, with prices rising 1.9 percent over the past 12 months, compared with a 2.1 percent rise over the year through March 2019. Despite the deceleration in headline inflation, core measures remains relatively stable. Core CPI inflation was 2.1 percent over the year through March, roughly in line with the 2.0 percent pace a year earlier.
Other price measures have shown restrained inflation pressures for some time. The headline Personal Consumption Expenditures (PCE) Price Index (the preferred measure for the FOMC’s 2 percent inflation target) has held below the target since November 2018. The 12-month headline PCE inflation rate slowed to 1.3 percent over the 12-months through March 2020 from 1.4 percent over the year through March 2019. Core PCE inflation was 1.7 percent over the year through March 2020, a bit above the 1.5 percent pace over the year-earlier period.
Policy Response
The U.S. government has applied significant expansionary policy, both fiscal and monetary, to buttress American households and businesses during the pandemic. On the fiscal side, roughly $2.7 trillion in financial assistance has been authorized, aid that is unprecedented in size, breadth, and speed. The Administration has disbursed funds directly to taxpayers in the form of Economic Impact Payments, and it has postponed payments for borrowers of federally-backed student loans. The self-employed and gig economy workers are now eligible for unemployment insurance benefits, and those who are unable to work due to the pandemic are eligible for a supplemental $600 Pandemic Unemployment Assistance benefit. And less than a week after its authorization, Treasury and the Small Business Administration launched the Paycheck Protection Program, working directly with private lenders to provide forgivable loans to small businesses. As a result, small businesses can retain their workers while maintaining solvency during this crisis.
On the monetary side, the Federal Reserve swiftly cut its interest rate target to zero and implemented large-scale purchases of Treasury securities and agency mortgage-backed securities. Additionally, the Federal Reserve has established numerous emergency lending facilities through which it will lend up to $10 per $1 of capital provided by Treasury. To date, Treasury has committed $215 billion of capital to these lending facilities and is able to commit up to $454 billion as conditions require. This degree of fiscal and monetary policy coordination is significantly greater in scale and faster in implementation than what was deployed following the financial crisis.
Conclusion
Although available data suggest that economic growth will slow further in the second quarter of 2020, we are convinced that the downturn will be temporary, given that its cause was not the result of any underlying imbalances in the economy. The U.S. economy has demonstrated significant resilience in recent years, and although the onset of the pandemic was an exogenous shock, our response to it has been swift and comprehensive, with a view to limiting any future damage to the economy. Even now, there are signs of stabilization in the initial claims data, instances of partial re-openings of the economy in some states, implementation of a second round of assistance to small businesses under the PPP program, greatly expanded unemployment benefits, and financial transfers to taxpayers. The bold steps the Administration has taken are designed to help boost incomes, maintain consumption, and preserve jobs. Additionally, the Administration continues its coordination with local and state policymakers in the shared mission to safeguard the health of American citizens and restore economic prosperity.