Hysteresis and other drags on recovery in the US
The US federal government has extended social-distancing guidelines until 30 April, which roughly corresponds to the end of current ‘stay-at-home’ orders decreed in major US states. But there are a number of reasons why re-opening the US economy will not be like flicking on a light switch.
One is labour-market ‘hysteresis’. In other words, the massive scale of layoffs already happening—especially apparent in the staggering weekly initial jobless claims—will take time to be re-absorbed.
This particularly differentiates the US system from Europe, where government-subsided job retention is designed to help reduce the damage (including long-term damage) to the labour market caused by sudden crises. The UK’s subsidised job retention scheme is an example. The Global Financial Crisis showed that the US labour market is quick to adjust on the way down, but less so on the way up. In other terms, firms face ‘friction costs’ in re-hiring workers while mass layoffs also risk triggering not only an enduring income shock but also a confidence shock for US consumers.
Second, some sectors will continue to struggle through a partial re-opening. Manufacturing, which accounts for just 11% of the American economy, could be less affected by social distancing, but other sectors such as construction, retail and restaurants will take longer to rebound. Third, the Achilles’ heel of the US economy is the shale oil sector, hurt both by the virus-related sudden stop in activity and the price war in oil. While oil and gas extraction is strictly speaking only 1.0% of US GDP, it is five times bigger when all associated industries are added.
Fourth, tight financial conditions could have a lasting impact. The US economy is particularly well correlated with high-yield bond spreads. Taken at face value, current spreads would suggest a 3-percentage point hit to US growth if they persist. The rise in bond spreads could have a lagged impact on the US economy lasting two quarters – i.e. spill over into the the second half of the year. Together with oil prices and unemployment claims, how financial conditions evolve before the US economy begins to reopen might be as important as the reopening itself. Finally, one could also add the recent strengthening of the US dollar, which penalises exports.
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