The U.S. economy grew at a faster pace than expected in the last three months of 2021, but clouds ranging from Omicron to higher interest rates are gathering over the recovery American.
Gross domestic product (GDP), which measures the total output of goods and services in an economy, rose 6.9% in the fourth quarter from a year earlier, the U.S. Bureau of Economic Analysis said Thursday. .
It was stronger than most analysts had expected, but the Omicron disruptions, which led to a wave of sick workers, likely weighed on growth during the last days of December and the first weeks of this year.
“The Omicron wave means the economy is starting 2022 on a much weaker footing and we expect growth to disappoint the rest of this year as well,” said Andrew Hunter, senior U.S. economist at Capital Economics.
A buildup of inventory at retailers and wholesalers led the growth charge in the fourth quarter. Consumer spending — which drives about two-thirds of U.S. economic growth — has also been healthy, but not as robust as in the first half of 2021.
For 2021 as a whole, the economy grew by 5.7% – the best performance since 1984. But that 80s vibe also comes with a downside – namely inflation.
Personal consumption expenditure stripped of food and energy – the Federal Reserve’s favorite inflation gauge rose 4.9% in the fourth quarter from a year earlier.
A myriad of factors drove economic growth in 2021. Government largesse in the form of massive COVID stimulus payments left consumers saving. Vaccination rollouts have led to the rollback of COVID restrictions that are undermining businesses. And when the economy reopened, consumers triggered strong pent-up demand that few saw coming.
Before COVID hit, American consumers were spending more on services than on goods. But virus-weary consumers turned their voracious appetites to goods as the economy reopened.
The result: companies did not have enough supplies to meet this massive increase in demand – an imbalance that triggered supply chain disruptions and shortages of raw materials, driving up costs for companies.
Meanwhile, the combination of government handouts and the Federal Reserve’s cheap money policies has also fomented a major disruption in the US jobs market.
The Fed cut interest rates to near zero and unleashed a host of other extraordinary measures in the first weeks of the pandemic in 2020 to help keep the US economy afloat during the shutdowns that took 22 million unemployed Americans. And the Fed kept those cheap money policies in place as COVID restrictions were repealed to help Americans get back to work.
The labor market has recovered well, but it has also changed significantly.
These low interest rates that stimulate employment have also inflated asset prices. As a result, many older workers who have seen the value of their homes and stock portfolios soar have decided to retire earlier. Government assistance also allowed workers to be more selective about how they earn a living, giving rise to the phenomenon known as the Great Resignation.
Far from being short of jobs, the US economy is currently posting an almost record number of job vacancies. And workers are so confident in their job prospects that they are quitting in record numbers.
Some workers gave free rein to their entrepreneurial spirit to start their own business, while others decided it was time to demand a better deal from their employers.
To attract scarce job seekers, companies have sweetened compensation packages with signing bonuses, bigger paychecks and better benefits.
Workers haven’t had this much power in decades. And they get a well-deserved raise. But these higher labor costs, combined with higher raw material costs, are fueling inflation.
Consumer price inflation is at its highest level since 1982.
With price pressures so strong, the Fed has refocused its priorities on reviving the job market and controlling inflation.
The most powerful tool at his disposal is the interest rate. On Wednesday, Federal Reserve Chairman Jerome Powell confirmed that the Fed would likely start raising interest rates in March.
But higher interest rates, while cooling inflation, also suppress economic growth, underscoring the balancing act the Fed is trying to achieve.
If inflation begins to soar too far too fast, expectations of higher prices on the horizon can become lopsided and force the Fed to raise rates sharply and possibly derail the recovery.
The Fed’s goal is to raise interest rates just enough to curb inflation while keeping the economy on a growth path.
Powell told reporters on Wednesday that the Fed has some leeway when it comes to raising rates. “I think there is enough room to raise interest rates without threatening the labor market,” he said at his press conference after the policy-making meeting.
This hawkish stance on inflation did not go down well with U.S. stock markets, which turned negative following Powell’s comments.
Yet despite the headwinds of higher interest rates, Omicron and lower government spending, many economists believe the economy will continue to grow this year. They just don’t see it growing as strongly as last year.