Market Overview

U.S. Policy Responses To Labor Market Distress

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The unemployment data tells the story of the economic damage in the United States better than any other data, and the numbers are overwhelming. In the monthly employment reports, over 20 million jobs were reported as lost in April 2020, and the unemployment rate was reported as a dismal 14.7%. This number is, unfortunately, on the low side since according to the Bureau of Labor Statistics many workers who were laid-off due to the pandemic were misclassified. This adjustment takes the unemployment rate to around 19%. Also, this jobs survey, taken in mid-April does not reflect the additional damage later in April and likely continuing into May and beyond. From March 15 through May 2, 2020, in just seven weeks, over 33 million people filed claims for unemployment insurance.

Given this level of job losses, one is drawn to make comparisons with the 1930s, as that was the last time the US saw 20%-plus unemployment. Be careful with drawing any parallels. This time around the cause was a pandemic and not a financial crisis; the speed of the economic collapse has been measured in weeks in 2020, and not in years; and most importantly, the policy responses are addressing the crisis immediately and in massive size, instead of denying the problem as was done during the first years of the Great Depression. Let’s examine the differences in a little more detail

US unemployment rate since 1929

US civilian payroll jobs

Labor Market Depression, Not A Financially-Induced Crisis

This pandemic event is a labor market depression and was not caused by a financial crisis. The economic lockdowns, which are now just starting to be eased around the world, caused a seismic shock that shutdown travel, closed restaurants, and hit service industries the hardest, then spreading to manufacturing and other sectors as demand collapsed. Back in 1929, when the stock market crashed, it caused a massive financial panic, with the banking system effectively locking up. In that sense, 1929 was more like 2008. More on that later when we discuss policy responses.

Speed Of Economic Collapse

Financial panics are characterized by massive deleveraging of the banking system over a course of months, leading into years. The deleveraging works like a domino-effect throughout an economy previously growing with support from out-sized debt creation. The economic lockdowns of this global health crisis, however, caused a phase transition known in physics as cascading network collapse. The decline is abrupt, measured in weeks. There is no long slide into massive unemployment as occurred over the four years after the 1929 stock market crash.  This time the worst of the damage has a good probability of being over much more quickly during 2020, with the rebuilding phase starting, albeit slowly, after the bottom has been reached. [For more on “Policy Analysis through the Lens of Phase Transitions” please see our research report at https://www.cmegroup.com/education/featured-reports/policy-analysis-through-the-lens-of-phase-transitions.html.]

Immediate And Massive Policy Responses

A key feature distinguishing 2008 from 1929 in the U.S. was the response of the Federal Reserve. Once the extent of the financial panic was clear in September 2008 after the poorly managed bankruptcy of Lehman Brothers and the messy bailout of the insurance giant, IAG, the Fed understood that decisive action was needed as the “lender of last resort”, to preserve the stability of the US financial system. Within just a few months, the Fed had purchased about $1 trillion of distressed securities, lifting that burden from the books of the banking system, as well as reducing short-term rates to near-zero and providing special support to several sectors of the financial system with emergency lending programs.

Back in 1929-1933, the Fed stood by and watched banks fail by the thousands. This was especially unfortunate, since the Fed had been created after the financial panic of 1907 specifically to serve as the lender of last resort for the financial system to prevent future panics from turning into depressions. The Fed failed its first test spectacularly in the 1930s. In 2008, the Fed rose to the occasion and secured the financial system and the economy against a repeat of the 1930s.

This time around in 2020, the Fed has pulled out the playbook from 2008, and then added several more trillion dollars of financial system support for good measure. The lesson from the 1930s was not to standby and watch helplessly. The lesson from 2008, was to act quickly, decisively, and with maximum force.

Fiscal policy responses were very different between 1929 and 2020, as well. The depression was well underway before the Presidential election of November 1932. Both candidates affirmed a commitment to fiscal discipline in the face of the crisis. Franklin D. Roosevelt won the election handily, and he was not long in office before he realized that massive stimulus and works programs were needed to reduce unemployment, and he quickly forgot about any desire for balanced budgets. With the Fed on the sidelines in the 1930s, the fiscal stimulus was critical in rebuilding the economy. We do note, though, that in 1936-37, there was a return to fiscal austerity which led to a setback in 1937 for the economy, and it was largely the war spending in the 1940s that conclusively ended the Great Depression.

After 2008 there was a sort of mini-austerity that took place largely as a result of political gridlock. A spending sequestration went into effect in 2011 and the 2001 and 2003 tax cuts were allowed to expire at the end of 2012 as well as a 2009 payroll tax cut. Slower spending growth and higher taxes helped to shrink the US budget deficit from 10% of GDP in 2009 to just 2.2% of GDP in 2016. In doing so, it placed more of the burden of supporting growth on the Federal Reserve which kept rates below 1% until the middle of 2017. In addition to the restraints on Federal spending, state and local government also slashed spending in the wake of the 2008 financial crisis and they did not begin to contribute to employment gains until 2013.

It was not until 2017 when spending restraint in Congress was lifted that the Fed could begin hiking rates more aggressively. The combination of higher spending and tax cuts grew the Federal deficit from 2.2% of GDP in 2017 to 5% of GDP in the eve of the pandemic.

In 2020, a divided and highly partisan gridlock in the US Congress was broken by the need to act decisively. Well over $2 trillion of spending has been approved and signed into law. The budget deficits are set to soar to $4 trillion a year by the end 2021, bringing them to around 20% of GDP and perhaps higher if Congress appropriates additional funds.

Most of the initial policy responses by both the Fed and the US Government fall into the category of “support” policies. Support policies are designed to cushion the economic ramifications of the cascading network collapse phase and to get one into the rebuilding phase. “Regenerative” policies work to increase the pace of recovery and rebuilding.

Federal reserve assets as a percent of nominal GDP

US annual federal budget: surplus or deficit

The Fed is not well-equipped for regenerative policies, as its work is primarily in the support column, to keep the financial system functioning and prevent the kind of financial domino-effect that can turn a recession into a depression. In effect, as the saying goes, the Fed cannot push on a string to make the economy grow faster.

Fiscal policy, however, can have considerable impact on the pace of rebuilding. The regenerative policies need to involve new spending that otherwise would not have occurred, and the more the focus is on putting people back to work, as a variety programs in the 1930s did, the more likely they are to quicken the pace of rebuilding the economy. That is, tax cuts are ineffective as the money often gets saved, while infrastructure building programs put money into new projects that get people hired right away, and that impact can ripple through the economy in a positive manner. The possibility of too quick a withdrawal of Federal fiscal support could present a downside risk to the prospects for economic recovery, as would sharp cuts in spending at the state and local level. [For those interested in the fusion of monetary and fiscal policy, please see our report “Modern Monetary Theory Makes Back-Door Entry Into Policies” here.]

The outlook is for more fiscal stimulus of the regenerative nature in the second half of 2020 and into 2021. And, we would note that the Fed can and already is operating in a manner to support the fiscal initiatives, by broadening its support operations to include municipal bond markets and corporate credit. Even with massive support policies in place, and plans for regenerative policies down the road, the phase of rebuilding the economy is likely to be slow and drawn out, given the extent of the damage to the labor markets and huge decline in demand as incomes have been diminished.

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