Written by Jason Ouyang
2021 was a crazy year, in general, especially in the macroeconomic sense. We saw Delta and Omicron variants and vaccines, the January 6th had an attack on the US Capital, a coup in Myanmar, the evacuation of Afghanistan, the Tokyo Olympics, and Texas froze over well before Michigan did. Through all of that, the US saw more than 4% real (inflation adjusted) growth and inflation for the first time in more than 40 years. The US also added 7 million jobs with wages increasing at the same time! With everything going on, all we can really do is look back and ask: what in the world just happened?
Surprisingly, there is a method to the madness of last year. Three large trends were defined last year, which can be summarized as COVID-19 itself, the response, and the response to the response. More specifically: the downward shock (COVID-19), the government’s response to the shock, and the economy’s response to the government action. This framework will be especially helpful when we analyze 2021 as part of the broader recovery from COVID-19 and compare the recovery to the recession in 2008.
To understand 2021, we need to generally understand how we got there… enter 2020. As a global pandemic COVID, it brought the world to a standstill in every imaginable way. Over 900,000 Americans have died of or with COVID, with upwards of 75 million Americans being infected at some point. Everyone had to drastically change their range of behavior. Social distancing and masking became the norm, with the looming specter of quarantine hanging overhead. Anything that could go online did as a response to the worldwide realization that attending events in person would inevitably kill people. No more dine-in restaurants, movie theaters, planes, meetings, office buildings, or anything face-to-face. All across the economy, demand collapsed, and GDP followed very quickly.
In 2021, the mRNA vaccines from Pfizer and Moderna were tested and found safe and effective- marking a clear turning point in the pandemic. Pfizer and Moderna vaccines became available to frontline medical workers in January, and to the general public starting in late April. Johnson &Johnson’s one-shot vaccine followed shortly. This breakthrough made safeguarding the public from COVID possible, allowing everyone vaccinated to start coming back together. Not only was the economy just starting reopening, but it could also reopen completely, instead of a carefully managed trickle of minimal interaction.
Vaccines and reopening the economy were only part of the 2021 story. The US government committed to unprecedented fiscal stimulus, and the Fed committed to almost unlimited monetary support for the economy. As a result of those incredible commitments, total real personal income skyrocketed. Below is the chart of real personal income, adjusted to 2012 dollars.
Your eyes are not playing tricks. 17 trillion in total real income went to 19 trillion, then peaking at 21 trillion in 2021.
Similarly, the personal savings rate also exploded at the same time.
This was somewhat predictable – after all, demand dropped drastically, and if you aren’t spending money, you’re saving it.
What this demonstrates is that fiscal and monetary support implemented by the US government successfully kept demand from falling as much as it otherwise would’ve during the long year of 2020. If market demand is a fireplace when the cold wind of recession blew, the 2008 government tossed in only a few wet logs, and the 2020 government dumped jet fuel.
That demand helped sustain the real growth in 2021, and massively accelerated the recovery from COVID-19. For comparison, look at this chart of real GDP from 2004 – to 2022. Compared to the Great Recession in 2008, the fast and furious support for the American economy helped real GDP recover nearly four times faster.
Now moving to the last part of our framework (the economy’s response to the government action) we start to see even more interesting trends caused by buckets of money sloshing around the shaken economy. Namely, over 7% annual inflation during the year 2021. In the US Bureau of Economic Analysis’ breakdown, the price of durables, nondurables, and food all went up, not to mention gas and energy prices. All this is almost unprecedented in comparison to the pre-2019 and 2008 recession.
From these charts, it’s clear that prices have gone up unilaterally. The data strongly suggests that stimulus boosted demand exceeded supply since supply is typically slower to react to a stimulus due to manufacturing lead times and more bureaucracy than one consumer’s impulses. When this happens, prices rise until quantity supply meets quantity demand, or by increasing supply or decreasing demand. As with a fire, when the economy runs a bit too hot, someone is sure to be burned.
These increases in prices helped erode much of the nominal growth that occurred in 2021, and depressed real wages compared to what it might have been. This inflation was likely driven by the loose monetary policy and generous stimulus packages that helped reflate the economy in the first place. In 2021, we got 4 years of economic growth compressed into one year – but we also got about 4 years’ worth of inflation as well. This strongly suggests that trying to stimulate the economy without inflation is a little like trying to run without breathing – the less you breathe, the less your legs can run!
These three factors – COVID-19, nominal and real economic recovery and growth, and inflation, are the three big economic stories of 2021. Hopefully, this article helped untangle the mess of economic narratives coming out of 2021 and helped structure thinking about 2021. Looking forward, the management of inflation, COVID-19, and the tapering of the stimulus will be the big issues moving in 2022, so long as nothing goes particularly wrong.
But who am I kidding? The only consistent fact of the 2020s so far is that we should expect anything but the ordinary.