U.S. economic output declined by an annual rate of 32.9 percent in the second quarter of the year, according to the U.S. Department of Commerce.
That is the largest quarterly decline in U.S. gross domestic product (GDP) ever recorded. Official U.S. government records of quarterly GDP are available only for the years 1947 and after.
The decrease in spending on services, caused by the government lockdowns, accounted for the great majority of the decline, CNBC reports:
“Personal consumption, which historically has accounted for about two-thirds of all activity in the U.S., subtracted 25% from the Q2 total, with services accounting for nearly all that drop.”
It is likely that this is the worst quarterly decrease for at least a century, with the short depression of 1920-1921 a close second. The latter depression was quickly remedied by the Harding administration’s swift action to cut government spending by 82 percent, decrease taxes, and allow interest rates to rise and prices to fall.
The U.S. House of Representatives and Senate are considering bills for additional coronavirus relief on top of the nearly $3 trillion spent so far.
Such a further increase in government spending would be a big mistake, says John Berlau, a senior fellow at the Competitive Enterprise Institute.
“It’s not surprising the economy is contracting, when governments have forced whole sectors to shut down and consumers are cautiously avoiding a variety of commercial activities they believe could endanger their health,” said Berlau. “But massive new spending is not the answer, and it would cause more economic harm.”
Benjamin Zycher, a resident scholar at the American Enterprise Institute, says the federal government’s initial actions directed toward sustaining consumer demand were justified, though Fed policy has been ill-advised in recent years.
“The fiscal response thus far has been O.K. overall,” said Zycher. “There was a real need to maintain consumption as much as possible, but I think that the zero-interest rate Fed policy is deeply unwise, and the growing effort to impose constraints on the slope of the yield curve is perverse.”
The economic contraction is a short-term shock best dealt with by allowing the private sector to fix what the government broke, says Brian Domitrovic, Ph.D., the Richard S. Strong Scholar at the Laffer Center.
“GDP can go up just as fast as it can go down,” said Domitrovic. “It was [government] force, along with a mass of private decisions to stay away from economic activity, that caused the drop. Absent the disease condition, GDP should snap back wholly. With persistent conditions, the snap-back should approach the original line on account of new practices developed to deal with it.”
It’s important to remember that the U.S. economy was doing very well before the coronavirus shutdowns, says Ed Hudgins, a senior fellow at The Heartland Institute.
“This is a recession different from all others, not only because the cause was the government reaction to COVID-19 but also because it was preceded by an economy stronger than any in many decades,” Hudgins said. “Sadly, the government-mandated shutdowns have put many smaller enterprises out of business permanently.”
Financing additional spending with more federal debt would only worsen the situation, says Don Devine, a senior scholar at the Fund for American Studies who served as President Reagan’s director of the U.S. Office of Personnel Management.
“In the long run, debt will slow everything down or worse,” said Devine. “The government has made its bed and will have to live with it.”
“Another aid package that is not tightly focused could be a ticking inflationary time bomb,” said Hudgins.
Instead of spending more borrowed money as Congress is considering, the federal government should turn to policies that have consistently proven to unleash economic growth, especially deregulation, says Iain Murray, senior fellow and vice president for strategy at the Competitive Enterprise Institute.
“This is as much a supply shock as a demand shock,” said Murray. “To get the supply side moving, we need supply side policies, to wit: deregulation and tax cuts on employers. Congress only seems to be talking about demand side help. There needs to be a deregulation title in any Phase IV relief bill. Some states and the [Trump] administration have done a good job on getting rid of never-needed regulations, but they need to go further. And the last thing we need is more job-killing regulation like expanding California’s AB5, which has made working from home difficult at exactly the wrong time.”
Regulatory reform would have a powerful effect in stimulating economic growth, says Berlau.
“What we need is a deregulatory stimulus: wholesale repeal of laws and regulations that keep businesses from adapting to serve customers given the realities of Covid-19,” said Berlau.
“Lawmakers should specifically concentrate on regulatory barriers to innovations that could help small businesses weather the storm,” said Berlau. “For instance, some restaurants have smartly opened food pantries and turned their sidewalks into sidewalk cafes. We should get rid of any rules or laws that prevent restaurants or other businesses from safely innovating like this to better serve their customers during these trying times.”
The government’s initial response of borrowing at unusually low interest rates in order to deal with a crisis was justified, says Hillsdale College economics professor Gary Wolfram.
“Given that the economic downturn was not due to failed actions of the private sector, I do believe it was necessary for the Federal Reserve to respond in the way it did,” said Wolfram. “Also, with 30 year Treasury bonds selling at the current rate, it can make sense to use fiscal policy to combat the pandemic and borrow at very long rates. Given that the long-term government debt problem is in the mandated costs of Social Security, Medicare, and Medicaid, I am not as concerned about running a deficit to deal with a unique temporary phenomenon.”
A full cure for the economy will probably have to await the development of a vaccine for the coronavirus, says Zycher.
“I think that there will be a continued slow recovery as individuals, businesses, and the market learn to make adjustments to the pandemic in ways that are increasing in efficiency,” said Zycher. “But I doubt that there will be a ‘rapid’ recovery, however defined, until there is a vaccine, an effective and inexpensive treatment, and until the achievement for the population of herd immunity, the minimum extent of which is unknown.”
Wolfram agrees that a full economic recovery depends on progress toward a vaccine, in which deregulation could play a big part.
“My feeling is that the market-based economy will result in a recovery in a reasonable length of time, but it will take the development of a vaccine,” says Wolfram. “One interesting aspect of this has been the removal of government barriers to innovation in the creation of a vaccine.”
Lawmakers should recognize that the fundamentals of the economy are good and government intervention is the problem, not the solution, says Domitrovic.
“The stock market is very interesting—it is saying don’t blow it, you can handle it,” said Domitrovic.
