Forecasting Recovery from the Covid-19 Recession: The Long (and Winding?) Road

The nation’s output, real GDP (i.e., GDP adjusted for inflation), took a big hit in the second quarter, falling almost 10%. Looking forward, should we expect an improvement in economic conditions for the remainder of 2020?

The second quarter includes the months of April, May, and June. Up to this point, April was the hardest hit month.  For example, the staggering unemployment rate of 14.7% in April declined to 13.3% in May, and to 11.1% in June.  For more recent unemployment data for July, we can look to weekly initial unemployment insurance claims for an indication of where the labor market is headed. The average weekly initial unemployment insurance claims in July are down over 8% relative to the average weekly claims in June. While there are some signs of concerns due to increases in weekly unemployment insurance claims over the last two weeks, it does not appear that economic conditions have worsened during July. 

At the beginning of July, the Congressional Budget Office (CBO) released their quarterly forecast of real GDP. The CBO’s forecast for 2020, beginning with the second quarter, is depicted in the following figure along with the actual estimate of real GDP from the Bureau of Economic Analysis. The CBO forecast a 10.1% decline in real GDP between the first and second quarter while the actual decline was 9.5%. For the next two quarters, the CBO forecast growth of 4.0% and 1.9%, respectively. Between 2019 and 2020, the CBO forecast a 5.8% decline in real GDP. So, relative to the second quarter, we are currently on track to see an increase in real GDP during the last two quarters of the year.

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What can we expect in the long-run?  The CBO forecasts extend out to 2030, and include forecasts of both real GDP and what is called potential GDP, or the GDP level we would achieve at full employment.  There are several notable features of this graph.  First, the peak of real GDP occurred in the fourth quarter of 2019.  Real GDP decline somewhat in the first quarter of 2020, and then cratered in 2020 quarter two.  This is labeled the ‘Trough’ in the figure, as it is projected by the CBO to be the worst point of the business cycle.  Real GDP is then forecast to rise, slowly but steadily, converging gradually to potential GDP, the full employment level of GDP.  Note that not until the third quarter of 2022 does the CBO expect real GDP to rise above the value it had achieved in the fourth quarter of 2019.  The CBO is not predicting a quick recovery.

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Posted: August 04, 2020 by Dennis W. Jansen, Andrew J. Rettenmaier