Economic Outlook: Still Rising

U.S. real GDP increased 1.6% (6.5% annualized) in the second quarter of 2021, putting it 0.8% above its prepandemic (fourth-quarter 2019) mark. Consumer goods spending led the recovery, boosted by stimulus checks and substitution by social-distancing consumers. Consumer services is quickly recovering, thanks to mass vaccination, but second-quarter 2021 spending was still down 3% from prepandemic levels.

We expect a gradual return to normal spending patterns over the next year, with goods spending cooling off and services spending continuing to recover. The remaining shortfall in services spending is driven by air travel, large events, and similar areas. Restaurant spending has actually fully recovered after being down 50% at the worst of the pandemic. We think the categories still in shortfall will eventually follow the complete recovery seen with restaurants but with a lag, reflecting the time needed to plan out trips and for consumers to get comfortable with larger crowds. In the short run, the services recovery should resume after the delta variant runs its course.

Over the medium to long run, the question of economic growth hinges on the supply side of the economy. We're about 3% above consensus on GDP growth through 2025, reflecting our views on the supply side. We think the U.S. economy was operating below its potential even before the pandemic (in 2019). In particular, labor force participation was still running below its long-run trend, owing to the lingering impact of the Great Recession. However, we think exceptionally tight labor markets in the next few years will provide discouraged workers the opportunity to rejoin the workforce. This incremental labor market recovery will boost GDP growth through 2025.

We still think high inflation will be temporary, as we're expecting only about 2.2% inflation in the core Personal Consumption Expenditures Price Index over 2022 to 2025. First, vehicles are driving the bulk of the excess inflation today, as supply is constrained by the semiconductor shortage. Yet we see no reason the shortage won't eventually end. Second, even if high inflation does spread to other sectors, we don't expect it to prove any more lasting than in the vehicle sector. Global supply chains have been strained by unexpectedly strong demand. But supply should catch up eventually, and pressures should also ease as consumers continue to rotate their spending from goods to services.