There’s No Template for a Pandemic Economic Recovery, so Atlanta Fed Economist Looks to WWII

June 21, 2021

Economic policymakers have noted often this past year that no textbook explains how to negotiate a global pandemic.

So where to turn for clues?

In decoding the modern economy, researchers typically rely on models and patterns based on past events. But the pandemic recession was not typical, and the standard economist’s tools were of limited use. A recession is by definition a shrinking of macroeconomic activity, but this one saw overall household income increase and consumption fall.

“If you want to know what will happen next, everything we know about recent economic events won’t be relevant because this is a very atypical, very strange recession,” Atlanta Fed research economist Federico Mandelman said. “So you go back in history.”

photo of Federico Mandelman
The Atlanta Fed’s Federico Mandelman. Photo by David Fine

Mandelman scoured the record for episodes similar to the pandemic economic crisis.

He didn’t find many. The Spanish Flu pandemic of 1918 to 1920 was a public health calamity worse than COVID. Despite the humanitarian disaster, the nation’s gross domestic product fell by only 1.5 percent, Mandelman pointed out.

The better economic analogy, he concluded, is the period surrounding World War II. Mandelman recently published an article in the Atlanta Fed’s Policy Hub exploring the parallels between the World War II period and the pandemic-induced economic crisis. The underlying causes are obviously different, but the broad contours of the economic effects are similar.

For starters, the nation’s entry into World War II triggered a surge in debt-financed government spending on the war effort. Factories were humming and needed workers, so household incomes held up. Meanwhile, consumer spending was severely curtailed because food was rationed, and industrial production shifted almost entirely to armaments, leaving relatively little for consumers to buy. The diminished spending on goods fueled a record jump in personal savings.

The war’s end unleashed pent-up demand. Government price controls were removed, and inflation leapt from 2 percent to 20 percent, the highest increase ever recorded in the United States, Mandelman wrote.

An excerpt from Mandelman's article, depicting the effects of postwar inflation on automobiles.

An excerpt from Mandelman’s article, depicting the effects of postwar inflation on automobiles.

However, the nation’s postwar shopping spree didn’t last. Moreover, contractionary fiscal and monetary policies combined with well-anchored inflation expectations helped the United States quickly return to 2 percent inflation within a couple of years, experiencing only a mild recession in the process.

Although today a global pandemic, not a war, is the underlying cause, many of the signature economic effects are analogous. Early in the pandemic, public health measures shackled huge chunks of the country’s consumer-driven economy. Savings rates soared as household incomes held up—supported by fiscal relief—while people had fewer outlets for spending. The fiscal relief cushioned the economic blow of the pandemic crisis but swelled federal deficits, much like funding the war effort in the 1940s.

The nation’s money supply—essentially the money available to the public to spend—increased 25 percent in 2020. But, Mandelman points out, savings rates jumped from about 5 percent of personal income to 25 percent. Even with extra money, many people chose to save rather than spend. Again, those dynamics are strikingly like the World War II period.

An inflationary spark, or not?

A surge in the money supply traditionally would have been viewed as a spark for inflation, since it means far more money chasing an unchanged supply of goods, sending prices soaring. It’s simple supply and demand.

Yet there is something else to consider. The key to why there was no crippling, long-term inflation after World War II, and might not be today, lies in what economists call the “velocity” of money—basically, how quickly it changes hands, Mandelman explains. Even though there was more money around in the 1940s, it circulated slowly because people had fewer things to buy.

“The open question,” Mandelman wrote in his article, “is whether the fall in velocity will reverse after the economy recovers from the pandemic, as it did in the aftermath of the Great Recession.”

Whether velocity picks up will largely depend on two related factors, Mandelman said: the labor market and people’s eagerness to spend as they get out and begin more actively participating in the economy. Rapid employment growth would more likely fuel inflation because workers would have more money to spend. So far, survey data show that consumers have remained frugal lately, even with the later rounds of fiscal relief.

At the same time, April 2021 inflation data show prices spiking in the short run, at least, particularly in categories most affected by clogged supply chains and economic “reopening.” For example, prices zoomed in lodging, used cars and trucks, car and truck rental, airfares, and public transportation.

Fed officials generally maintain that price pressures from supply chain bottlenecks and pandemic reopening are likely to fade over the coming months and are thus unlikely to feed troublesome long-term inflation.

“We don’t know yet whether the reflationary or stabilization forces will ultimately dominate in this extraordinary event, which has little to no resemblance to past recessions,” Mandelman wrote.

The World War II experience ended reasonably well for the U.S. economy. It remains to be seen how the pandemic economy ultimately plays out.

photo of Charles Davidson
Charles Davidson

Staff writer for Economy Matters

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