Morgan Stanley
  • Thoughts on the Market Podcast
  • Feb 9, 2021

The Fed, Stimulus and “The High-Pressure Economy”

With Chetan Ahya


Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Economist and Global Head of Economics for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the U.S. economic recovery and the debate over the path of policy tightening. It's Tuesday, February 9th, at 11:00 a.m. in New York.

Are you familiar with the term "a high-pressure economy"? If not, now might be a good time to get acquainted with this phrase, coined by economist Arthur Okun and referenced by current Treasury Secretary Janet Yellen back in 2016. Why now? Because this phrase encapsulates where we think the U.S. economy is headed over the coming quarters.

In short, a high-pressure economy is when continued expansionary policy creates stronger than average economic growth and low unemployment. Drawing on the experience from the past cycle, policymakers believe that such a high-pressure economy will create a broad-based and inclusive economic growth environment. And this will help to both reduce the impact on lower income households from the effects of the recession, as well as address the preexisting condition of income inequality.

With 2020 fourth quarter data in hand, we now know that final domestic demand has already reached 99% of its pre-COVID levels and is expected to rise to 100% by this quarter. Yet if you've been following the comments of policymakers in the U.S., you are probably familiar with the narrative that the Fed views any talk of tapering its asset purchases as premature and has hinted that the first rate hike in this cycle could be later than 2023. They have altered their policy framework to aim for maximum employment and for inflation to overshoot about 2% in this cycle.

In the meantime, the Biden administration is pushing for another COVID relief package. If this package is passed, it will result in a second consecutive year in which the federal fiscal deficit will be in the mid-teens, and this will be the widest it has been since World War II. In other words, macro policies are set to remain very reflationary, despite the economy having already made substantial progress in its recovery.

The consensus, though, is doubtful on the prospects for a strong economic resurgence, arguing that the shock of this pandemic has led to scarring effects. The consensus is forecasting U.S. growth of just 4.1% this year and 3.5% next year, and these forecasts imply that the U.S. economy will not reach its pre-COVID path over this forecast horizon.

However, a high-pressure economy is our base case at Morgan Stanley. First, we have consistently argued that there has been limited damage, if at all, to private sector confidence, thanks to unprecedented policy response in underwriting corporate and household income losses. And second, we think policymakers have learned from their experience in the previous cycle that there are positive benefits of running a high-pressure economy. We believe that policymakers are doubling down on their efforts, particularly post the COVID recession.

Our Chief U.S. Economist, Ellen Zentner, now expects the U.S. GDP to grow at 6.5% in 2021 and 5% in 2022. This means we will be getting to a situation where GDP will be even higher in 2022 than what we would have forecast back in January of last year. And that's a particularly remarkable outcome, especially when you consider that in the post global financial crisis period, the U.S. economy never really reached its pre-recession path.

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If you’re not familiar with the concept of a high-pressure economy, now might be a good time to get acquainted. A new forecast for the U.S. economy.

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