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What we learned about the economy in 2021


For once, the government tried overheating the economy. For better and worse, it succeeded.

By Neil Irwin


For people who study the vicissitudes of the economy, 2021 was the most interesting year of the 2000s.


It was not the most dramatic (that would be 2008 or 2020), and neither the best (2000 or 2019) nor the worst (2009). Rather, it was a year in which economic dynamics that had seemed entrenched for decades came apart or changed in fundamental ways. Workers attained the upper hand over employers; supply chains broke; inflation surged; and the economy rebuilt itself from its depressed pandemic levels with astounding speed.


In contrast to the last economic cycle, the government tried overheating the economy for once. For better and worse, it succeeded.


The unemployment rate, 6.7% in December 2020, fell to 4.2% 11 months later. That same shift took 3 1/2 years in the last expansion, from March 2014 to September 2017.


But the flip side has been soaring prices and many goods in short supply. Inflation has reached its highest levels in four decades. In surveys, Americans are remarkably unsatisfied with economic conditions. The growth numbers have been good. The vibes have been bad.


These are the most important things to learn from a year in which the economic ground beneath our feet shifted.


Yes, you can overheat the economy.


In the early months of 2021, there was vigorous disagreement between people in the centrist and left-of-center economics worlds. Was the $1.9 trillion pandemic rescue plan the Biden administration enacted, on the heels of a $900 billion bipartisan package passed in the final weeks of the Trump administration, too big relative to the hole the economy was in?


For example, in February, the Congressional Budget Office projected that the 2021 output gap — the economy’s shortfall relative to its full potential — was only $360 billion. Even if you think the CBO numbers are too cautious, estimates like that implied that the pandemic relief that passed a month later would send too much money coursing through the economy and result in inflation.


That, anyway, was the interpretation by traditional models of how fiscal stimulus works. Defenders of President Joe Biden’s approach emphasized, among other things, risk management — doing everything possible to get money into Americans’ hands, aggressively roll out vaccinations and get the economy back to its pre-pandemic path as quickly as possible.


These views were shaped in large part by the experience of the last expansion. Fiscal austerity was a major reason for a painfully long slog out of the global financial crisis. After years or arguably decades in which the central crisis was an underheated economy, the experience of 2021 is a reminder that overheating can cause its own discontents.


With demand for goods exceeding supply, especially for physical items, it is clear that the surging prices and other related problems (shortages and shadow inflation) are now America’s central economic problems. Economists will debate how much they are attributable to excess stimulus for years to come. But regardless of where one comes down on that question, the events of the last few quarters are a reminder that just because the risks of overheating were dormant for a long time does not mean they have gone away.


When supply chains get messed up, it is hard to un-mess them.


The disruptions to supplies of all sorts of goods have their roots in the earliest weeks of the pandemic, when manufacturers the world over pulled back on production amid collapsing demand and a public health crisis.


But things did not play out as in past recessions. Demand for physical goods surged in late 2020 and into 2021 — not like a typical recession in which demand for cars and other big-ticket items is depressed.


That happened because consumers shifted their spending toward physical goods and away from services, and government support kept incomes stable, preventing a collapse in overall demand.


The result: an economywide occurrence of the “bullwhip effect,” a phenomenon from the field of operations management in which small shifts in demand ripple through supply chains to cause wild swings.


The complexity of modern global supply chains and the fact that this bullwhip effect has played out across countless industries has made it a fiendishly difficult problem to solve. The issue is not just a shortage of semiconductors, or shipping containers, or any other single item. It is shortages of all these things crashing together in ways that make the feeling of scarcity and shortages more intense.


More power for workers does not necessarily make workers happy.


The tension between soaring demand and pandemic-limited supply showed up in the labor market in 2021 as well. The result was that workers were in command to a degree not seen in at least two decades.


This showed up across multiple dimensions. Wages have been rising rapidly. Companies have been forced to be more creative, flexible and aggressive in attracting a workforce. The rate of people quitting their jobs soared. After two decades in which employers were mostly able to have their pick of workers, the tables had turned.


And people hated it.


That is an exaggeration, of course. The Great Resignation is real, and plenty of people have taken advantage of this moment to secure a better, more rewarding employment arrangement. But in the aggregate, people view the state of the economy as horrendous.


In a Gallup poll in early December, 67% of adults said the economy was getting worse. Overall economic confidence matched its lowest levels from the early days of the pandemic and was lower than it was in the very weak economy of 2010 and 2011.


Some of this is surely tied to the fact that prices are rising more quickly than average wages, which means an average worker’s purchasing power is declining. Wage gains have been highest, in percentage terms, in lower-paying industries. In effect, hourly workers have been securing raises, while middle-managers and white-collar workers are, on average, losing significant ground.


People really, really, really do not like inflation.


For Americans younger than 50 or so, inflation is something you read about in history books or in articles about other countries. At least it was this time a year ago.


That changed abruptly in 2021, for reasons involving the economic dynamics discussed above. Even if the rate of inflation comes down in 2022 — if prices rise more slowly — it is readily apparent that inflation is weighing heavily on Americans.


But 2021 has made it clearer why inflation is less of a micro story about how higher prices affect individuals and more one of generalized discontent.


For one thing, this inflation surge has manifested itself in ways beyond those easily measured — in poorer customer service because of labor shortages, less selection on store shelves and more hassle planning Christmas gifts far ahead of time.


For another, during a pandemic and a time of profound polarization, high inflation adds to the sense that the world is a chaotic mess and will only get worse.


And finally, it is natural human psychology to view the negatives of inflation (higher prices for consumer goods) and its positives (higher wages) differently. That pay raise was money I earned fair and square; that higher grocery bill is an affront done to me by powerful forces beyond my control.


All that speaks to the central challenge for economic policymakers in 2022. For all the progress the economy made in 2021, it felt like a period of scarcity and want, whatever the growth numbers say. Achieving better vibes in 2022 depends on making it a year of abundance.

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