COVID-19 Impact Update: US GDP to plunge to -13% in Q2, unemployment approaching 9.0% by December

As COVID-19 cuts through the economy, we're issuing this 2nd update to our forecast published 5 March. It shows a sharper contraction than the first update, with 2nd quarter GDP growth plunging to -13%, GDP contracting 1.7% in 2020 (year over year), unemployment approaching 9% by December, and inflation slipping to 1.3% in 2021.

In this forecast update, recovery from the looming economic contraction begins in August, by which time we expect the rate of new cases of coronavirus disease 2019 (COVID-19) to be dwindling and quarantines, official and self-imposed, to be lifting. It is not until the fourth quarter that a firm rebound takes hold. GDP growth in 2021 is projected at 3.8% (year over year), but the economy does not regain full employment until 2023. By the end of that year, the stocks in the S&P 500 Index recoup recent losses.

Below we detail recent developments that have been incorporated into this update, and offer some closing thoughts on uncertainty, risks, and societal costs:

• Foreign growth. Our country analysts have issued another interim markdown in projected growth outside the US. In this update, trade-weighted (by US export shares) foreign GDP declines -0.2% in 2020 (measured year over year) as most countries are projected to fall into recession. This compelled downward revisions to our projections for US exports.
• Energy. Our energy team has revised further downward its near-term projections of oil prices, showing the price of Brent crude dropping to nearly $11 per barrel in the second quarter before starting to rebound. This compelled another downward revision in our projections of investment in mining structures, which we now see falling 60% by the end of the year. Falling gasoline prices provide only a partial near-term offset to this collapse in energy-related investment spending.
• Consumer spending. We have deepened and accelerated our assumed "shocks" to components of consumer spending at risk to policies of social distancing, with declines by April of between 40% and 90% in transportation, entertainment, gambling, lodging, food away from home, and travel, with no recovery until August and full recovery not until June 2021. There is a strong substitution to food at home, but in that shift much of the value added by restaurants is lost. This update shows personal consumption expenditures falling at a 16% annual rate in the second quarter before rebounding strongly in the fourth quarter. We're closely following high-frequency data from trade associations with an eye toward revising our assumptions as warranted. In addition, with many retail establishments being shuttered, we've extended the direct "hit" to expenditures on goods, both durable and nondurable. Light vehicle sales fall 16% in the second quarter.
• Auto shutdown. The auto industry has announced a temporary shutdown of production facilities at least through the end of March. We assume the shutdown last several weeks into April. This looks increasingly optimistic. Other industries are likely to follow suit.
• Unemployment. Given the timing of the BLS survey of establishments, job losses will not show up in the official data until next month. When they do, we expect them to be large and occur much faster than the usual relationship between slowing GDP growth and a rising unemployment rate. Accordingly, this update shows 7 million jobs lost in the second quarter. The unemployment rate rises to 8.8% by the fourth quarter. We're watching initial unemployment insurance claims for verification of our assumptions. This week's claims showed the very leading edge of the effect of the COVID-19 spread. Claims will jump very sharply in the weeks ahead.
• Credit conditions. As unemployment rises and amidst financial uncertainty, banks will tighten lending conditions. In our modeling, this impedes housing starts, particularly for multi-family units. Total starts decline 250,000 by the fourth quarter. We've also allowed for temporary 5% declines in both state and local and private nonresidential construction, with full reversal not until mid-2021.
• Initial financial conditions. The stock market has fallen over the last week, volatility has increased, credit spreads have widened, and the dollar has experienced some upward pressure. We've adjusted the forecast to reflect these tighter initial financial conditions.
• Monetary policy. While the Fed has resurrected several credit facilities from the 2008-09 financial crises, and is purchasing large amounts of Treasury securities in an effort to maintain normal functioning in financial markets, we have not changed our basic assumptions about monetary policy. The federal funds rate will remain near zero for the foreseeable future. We do not expect negative short-term interest rates. An aggressive move towards QE remains a possibility.
• Fiscal policy. An emergency relief bill has been enacted that CBO estimates will result in $7.6 billion of discretionary outlays through 2030, but only $1 billion this year. We have not yet included this in our forecast, but the amounts are too small to make much difference. A second bill that would provide for testing, unemployment benefits, and paid sick leave has passed both chambers of Congress and we expect it to be signed by the President. This has not yet been included in the forecast as we remain uncertain about the cost of the legislation. A third bill is taking shape in the Senate that likely will include financial support in the form of loans or loan guarantees for affected industries and, perhaps, cash payments directly to individuals—the latter being a popular proposal. In this update we do assume one-time cash disbursements of $500 billion to individuals during the second quarter. However, most of these payments will go to people who remain employed and therefore likely will be saved. The rest will go to people who become unemployed, and we assume they spend all of it over several quarters. The resulting stimulus boosts second quarter GDP growth by less than a percentage point. The federal deficit (as defined in the National Accounts) spikes to nearly $3.5 trillion (at an annual rate) in the second quarter, and rises to $1.8 trillion for this fiscal year. Because most of the cash disbursement is saved, the personal saving rate temporarily spikes to 21% in the second quarter.

Our forecast assumes that the shock to the level of consumer spending traces out a steep drop in March and April, a flat valley through July, and a gradual recovery from August to June of 2021...a hockey stick, or perhaps the Nike "swoosh". Yet even that delayed and subdued recovery implies quite aggressive GDP growth rates in the fourth quarter of this year (6%) and the first quarter of next year (8%) before growth slows back closer to trend by the end of next year.

Of course the uncertainty surrounding these projections is immense. With events changing rapidly, this forecast update could well be out of date by the time this note is read. Having said that, it is easier to imagine further downward revisions to the forecast than upward revisions. The shutdown in the auto industry could last much longer than assumed here and spread to manufacturing generally. With global air travel on life support, our assumed rebound in Boeing shipments and production (will likely be pushed back as orders are cancelled. The 2020 census could well be delayed. Many retail outlets are closing, so sales of retail goods could fall more than we assume here even if consumers make up some of them with online purchases. Policies of social distancing might not "flatten the curve" enough to prevent our healthcare system from being overwhelmed. These are just some of the imponderables.

Finally, we're starting to think about the economic costs of the COVID-19 pandemic. One way to compute this is to cumulate the difference between GDP in this updated forecast and GDP in the most recent forecast that did not show significant effects of the pandemic. Using this method we estimate that, over the next five years, the pandemic will cost the economy $1.5 trillion (2012 dollars) in foregone GDP. In addition, the recession casts a shadow forward on potential output, which remains slightly below the pre-virus path for several years after 2024. Hence, the cost of the pandemic continues to rise even after the economy regains full employment, albeit at a much slower pace than during the recession itself.