A vital focus on
Government efforts initially buoyed the economic recovery but a lack of support could jeopardize future growth
>> Quick takes:
- Critical juncture for government policy
- Fiscal and monetary policy providing key support
- The absence of policy support threatens nascent economic recovery
- Economy will not fully self-correct during the pandemic
- CRE could face greater headwinds without policy support
Due in no small part to government policy, economic growth should rebound robustly during the third quarter after contracting sharply in the second quarter.
Although the fallout from the coronavirus pandemic on the economy proved severe, the downside was lessened by both fiscal stimulus and monetary policy measures. After the acceleration of the crisis in March led to locking down and shutting down widespread swaths of the economy, government policy moved quickly (if imperfectly) to limit the damage. On the fiscal policy side, the federal government approved multiple rounds of spending, providing critical support for front-line healthcare, households, businesses, and state and local governments. The total spending amounts reached record-high levels on both an absolute and relative-to-GDP basis. Meanwhile, the Federal Reserve (Fed) took equally aggressive action on the monetary policy front, going beyond what it had implemented just a decade earlier during the financial crisis. The Fed slashed interest rates to zero and implemented its broadest intervention into the capital markets ever via the purchase of government bonds, corporate bonds, and ETFs.
These interventions clearly proved their usefulness and buoyed the economic recovery. On the fiscal policy side, federal government support caused year-over-year income for many households to surprisingly increase, propped up consumer spending which rebounded faster than many anticipated, helped keep companies in business while preventing (or at least delaying) layoffs, and provided some support to state and local governments, many of which remain constrained by their inability to run deficits and borrow to finance their spending. Meanwhile the Fed successfully kept the capital markets from seizing up the way they did during the financial crisis. While many will instinctively think of the rising equity markets, the debt markets provide even better support for this view: interest rates remain at low levels across various debt instruments, interest rate spreads versus treasuries did not widen out dramatically, debt originations persisted at robust levels, and access to capital continued for most borrowers.
Why does it matter?
But why does government support matter so much now? The answer lies in the fact that this downturn is truly different. The pandemic is negatively impacting the economy in a way unlike a typical downturn, even one as severe as the Great Recession. The pandemic is limiting the ability of the economy to function normally for two related reasons. First, certain businesses remain closed or operating at a limited capacity (e.g. bars, restaurants), typically due to government edict, because of health considerations. Second, many consumers continue (and will continue) to avoid patronizing certain businesses (e.g. airlines, hotels) out of fear of falling ill if they do. With aggregate demand and consumption spending limited, the normal self-corrective mechanisms in the economy are not working properly. For example, during downturns demand for goods and services declines, but does not evaporate because some consumers continue to frequent businesses, particularly if prices fall as typically happens. But now many consumers who might otherwise capitalize on cheaper prices cannot or will not. And companies, aware of this fact, are not increasing production. That is breaking what is known in macroeconomics as the Circular Flow of Income. Essentially, consumers use their income to purchase goods and services from firms who in turn take that income and pass it along households in the form of wages, dividends, etc. In exchange, households are willing to supply labor, capital, and resources to firms that invest and produce the goods and services demanded by consumers. And of course, all that activity generates important tax revenues. With spending on goods and services impaired, the cycle breaks. Until the pandemic subsides or ends, this cycle cannot self-correct like it does in a more typical recession. Government spending proves vital while consumption spending by consumers and investment spending by firms remains limited.
Circular-flow of income... what's wrong?
A critical juncture
The brings us back to this week. Congress has returned from recess, but they are running out of time if they are going to pass another spending package and provide necessary support to the economy. With roughly seven weeks until Election Day, the sands in the hourglass are running out. Soon campaigning by many in Congress will shift into a higher gear, taking them away from Washington, and severely limiting the ability to pass additional spending. In typical economic times the issue of government spending makes for a lively policy debate. But these are not typical economic times. Without another meaningful spending package, the nascent economic recovery will at a minimum shift to a slower speed, stall outright, or even worse, shift into reverse.
On the monetary policy front, the Fed continues its aggressive stance, even recently altering its inflation targeting mechanism to allow inflation to potentially run above its long-run target, focusing on the average over a period of time and not the reading during any individual period. At its meeting this week the Fed will likely start incorporating its new, more malleable stance on inflation into its guidance, but we do not anticipate any significant changes to policy. With financial markets working well, the Fed will likely remain confident in its current stance.
This juncture reminds us of a point we have made frequently and emphatically over the last four years. Monetary policy alone remains limited in its ability to support the economy. Fiscal policy clearly still plays an important role. Even Chair Powell makes this point repeatedly. The 2010s proved that hypothesis true, but the crisis of 2020 makes the point even more emphatically.
| What it means for CRE |
For CRE, the path forward remains, as ever, dependent upon the health of not just the overall economy but key constituents within the economy. If support for businesses expires that will likely mean a greater number of layoffs, including among office-using staff, a net negative for the office market’s ultimate recovery. If consumer support expires, especially among households below the median income level, more retailers will struggle and potentially fail completely, creating headwinds for retail. That could also have knock-on consequences for hotel demand as the economy recovers. Even the multi-housing sector could experience demand impairment down the quality spectrum.