January 2022 | Vol. 27 No.1

by Fred Ashton, Senior Economist, NEMA, and Don Leavens, Vice President and Chief Economist, NEMA

Recent data releases suggest that the economy regained momentum in the fourth quarter after decelerating during the summer amid another wave of COVID-19 cases, disruption from Hurricane Ida, and auto plant closures caused by a shortage of microchips. Elevated consumer savings and business cash holdings against a backdrop of abundant liquidity and pent-up demand for services provide a solid foundation for enduring economic growth. Federal stimulus such as the recently enacted Infrastructure Investment and Jobs Act, IIJA, will provide modest support beyond the two-year forecast horizon.

While growth prospects are promising, the pain from entrenched inflation, labor shortages, and supply chain constraints is likely to persist. The economy is restructuring in the wake of the business lockdowns in 2020 and the evolving solutions to the pandemic threat. Non-residential investment in structures is struggling to respond to shifting trends in demand for activities such as traveling, dining in restaurants, working from home, attending entertainment venues, and homeschooling. Developers have delayed and canceled construction projects conceived before the impact of the pandemic. At the same time, demand has soared for retrofitting buildings to comply with social distancing and ventilation requirements instituted to curb viral transmission.

Housing demand has also shifted higher, but builder response has been constrained by labor, land, and material supply shortages and rising costs.

Equilibrium forces in the form of price signals will resolve supply shortages longer term, but likely not soon enough to prevent heightened inflation from bleeding into expectations and threatening an extended bout of elevated inflation. Inflationary pressures pose a challenge to the Federal Reserve, which recently signaled the possibility of wrapping up the taper process a few months sooner than the original June deadline announced in November. This policy change and comments from a few Fed Board members acknowledging that inflation is running higher and for longer than initially anticipated could lead to a faster timetable for raising rates towards normal levels, possibly as soon as mid-2022.

With parts of the economy still struggling to recover from the 2020 contraction, a faster-than-expected timetable to normalize monetary policy could threaten the economic recovery. The government action seen worldwide in response to the Omicron variant could add pressure to an already strained supply chain and slow the normalization of economic activity.

Considering previous Fed statements, the Fed is likely to err on the side of less aggressive tightening even if inflation is slow to subside. Chair Powell reiterated that sentiment in testimony given to the Senate Banking Committee, asserting that accelerated tapering should not be an indication that rate increases will immediately follow. As a result, an uneven recovery is expected to continue along with inflation, labor shortages, and periodic surges in COVID-19 cases.