MSU Economic Forecast Model
Michigan 2022 Economic Outlook
Uncertainty is the one certainty that has defined this economy over the past few years and the advent of COVID-19 only contributed to that uncertainty. Though we make strides in controlling the COVID-19 pandemic, it has extended its stay through various mutations including the Delta variant and now the Omicron variant. The good news is that while the Omicron variant appears to be more transmissible than prior variants, it appears to have relatively milder symptoms. This realization seems to be the key to economic growth optimism for 2022.
2021 in review.
Following the tumultuous 2020, 2021 was nothing if not unusual. Most economic forecasts for 2021 pointed to guarded growth, though those projections were both tempered and reinforced through the course of the year. COVID-19 and consumers’ response to COVID-19 was the key variable to watch. Forecasts coming into 2021 largely speculated on the rate of vaccinations, where more optimistic forecasts largely anticipated high rates of vaccination, while more pessimistic forecasts saw new vaccinations plateauing early. While most eligible Americans were getting vaccinated against the SARS-CoV-2 virus in April of 2021, a new more contagious variant, Delta, was spreading globally – negating economic optimism for 2021. However, consumers continued to spend, partially driven by expansionary fiscal policies like student loan deferrals, eviction prohibitions, stimulus payments, and extended unemployment insurance periods. The year also saw widespread labor shortages that appear to be attributed to the pandemic. For instance, the labor force contracted by nearly 4 million workers in the first year of the pandemic. In 2021, it only grew by around 1.5 million workers – well short of labor force growth in years leading up to the pandemic. Economists warn that 2022 may see the labor market shed more workers in what is being billed “The Great Resignation.”
Many saw expansionary fiscal policy as the reason for labor shortages, but as labor shortages were experienced around the globe and as shortages persisted after unemployment benefits were pulled, it is hard to attribute labor shortages to overly generous social programs. The labor shortage we see today may be structural, meaning that the labor force has been permanently altered by the pandemic. Two-earner, two-parent households decreased in 2020 and 2021 attributing to the need to manage children’s at-home education. Older workers, already at odds of recovering from a job loss have in increasing numbers opted to retire early and live off the savings built over a lifetime. Keep in mind that Baby Boomers are the wealthiest generation who contributed savings over their working lives into financial markets with unprecedented long-term gains.
The extent of job loss is unprecedented in the face of a growing economy. While the economy continues to hum along, it is doing so with fewer workers. A large part of what we saw in 2021 was consumers spending from savings generated in 2020. That is, in part because of fiscal expansion and cautious consumer savings, households generated wealth in 2020, that they then sought to spend in 2021.
Consumers remain cautious on spending and what spending they are making may be attributed to adjusting to the new economic and work realities. Businesses and households alike spent heavily on durable goods between 2020 and 2021, including home and workplace improvements and modifications, automobiles and others. These purchases have been further buoyed by easy monetary policy of the Federal Reserve which kept interest rates low. This spending spree leads to the second big economic story of 2021.
Supply disruptions were rampant throughout 2021. Many examples exist, from periodic stock-outs of favorite grocery items to all-out shutdowns of major assembly lines. The auto sector suffered supply constraints on microchips, which are increasingly key components of our cars and trucks. To stave-off shutting down assembly lines, auto makers created a huge inventory of new cars without computer chips, while showrooms were left empty. This caused a run on used cars where, for some models, the offer price of used vehicles exceeded the list price of a new one. Similar supply constraints were found in other heavy machinery segments, including recreational boats, farm equipment and construction equipment. The global supply constraints can be attributed to work stoppages caused by labor shortages and supply disruptions for intermediate goods. Supply constraints can also be attributed to international shipping logjams blamed on the insatiable U.S. demand for imported goods. Though currently off its peak of about 100 container ships, the massive fleet of container ships queued for unloading at the Ports of Los Angeles and Long Beach stymied deliveries to other ports, effectively disrupting shipping across the globe.
With high demand and low supply, prices will rise, and 2021 saw the first hints that inflation still exists. For the past decade or more, economists’ inflation barometers seemed broke. What use to be a predictable inverse relationship between inflation and the unemployment rate appeared to break down. Historically, an overly tight labor market would indicate that demand for goods exceed supply of goods and therefore, buyers will bid up prices resulting in inflation. We saw tight labor markets come and go with little evidence of inflation. However, the current supply constraints along with high consumer demand has brought inflation fears back to life, even in the absence of tight labor markets. As the first COVID-19 year saw consumers pull back on spending, inflation remained around 1.1 percent. This compares with expected 6.7 percent inflation in 2021 and because supply constraints appear fixed for the foreseeable future, expect that inflationary pressures will continue through 2022.
2022 Economic Projections
So, what’s in store for 2022? Like the forecast for 2021, a lot depends on COVID-19 and the public’s willingness to get vaccinated. While current vaccinations may not stop the spread of COVID-19, especially the Omicron variant, evidence suggests it reduces the personal risks associated with exposure to the SARS-CoV-2 virus. We anticipate that as individuals perceive less risk from COVID-19, new norms for the economy will be experienced. However, new norms will likely look a bit different than norms before the pandemic.
The end of 2021 saw a gradual tightening of the labor market. Expect this to carry on through 2022 and for wages to continue to rise in response to labor shortages. Wage gains made in 2021 and 2022 will likely be partially or fully eroded by rising prices. That is, if one’s wages increase by five percent, but inflation (the cost of living) increases by six percent, the real change in one’s wages is a reduction of one percent. Anticipate inflation to be a leading economic story throughout 2022. The rise of inflation and its impact on labor’s income gain may be a call to arms for the labor movement.
The end of 2021 also saw the rise of the Omicron variant to the extent that the rate of new infections is slated to exceed the highest daily rate of new infections of 250,000 observed in January of 2021. The Omicron variant may not be as virulent as past variants, giving rise to optimism that 2022 will continue the economic growth of the past. We are not so optimistic, as the Omicron variant is now dominates new cases in the U.S. and that hospitalizations now exceed the worst cases to date in many regions. Hence, we anticipate further headwinds against economic growth that will ultimately slow but not stall future growth. We anticipate that COVID-19’s impact on labor markets and supply constraints will ease. However, international trade logjams will persist well into 2022.
The Federal Reserve appears poised to reverse quantitative easing in response to a now tight labor market and observable rise in inflation. Core interest rates will rise causing a rise in rates for new mortgages, credit card debt and for business loans. Inflation will also factor into interest rates, as lenders seek rates of return that exceed expected inflation. Higher interest rates tend to impose on housing prices, as higher mortgage rates effectively increase the cost of a house purchase. Buyers will seek to pass that cost onto sellers. Higher interest rates will also discourage new business investments. What the Federal Reserve will do in 2022 will largely determine whether an economic contraction will be realized in the year. A lot hangs in the balance, so watch monetary policy in 2022.
While the surge in durable goods manufacturing demand was the big surprise in 2021, we anticipate a slight reversal in 2022. That is because we anticipate that consumer demand for new durable goods have largely been saturated. We also see continued supply constraints hampering deliveries and contributing to price increases or the absence of promotional pricing in 2022. We also anticipate non-durable goods sales to continue to surge, while services will continue to lead in economic and employment growth. The Leisure & Accommodation sector remains the big “what if,” and its direction largely depends on COVID-19.
Updated December 28, 2021