Section I: United States Economic Overview
Introduction
We begin with a brief discussion of the US economy to set the stage for understanding West Virginia. This contextual material is vital to understanding the West Virginia economic outlook because national growth is a key driver of state growth.
While the United States economy has now generally recovered from the sharp recession that was driven by the COVID-19 pandemic, a new wave of significant uncertainty emerged in late-2021 that continues to have the potential to trigger a new recession. The cornerstone of this new wave of uncertainty surrounds inflation. For around two years now the US has suffered rates of inflation that are noticeably above what is considered unacceptable by the monetary policymakers in the nation.
This surge in inflation was catalyzed at least four factors: First, global supply chain constraints emerged during the pandemic, driving up prices for goods that were in short supply, such as automobiles. Second, widespread workforce shortages emerged during the pandemic as many men and women left the labor force. These workforce shortages lead to more aggressive wage increases to attract workers to fill job openings, and these wage increases typically filter through to higher consumer prices.
Third, energy prices rose substantially in 2022, due to several factors—one being Russia’s invasion of Ukraine. High energy prices not only have a direct impact on overall inflation, but filter through to increase the price of goods and services more broadly due to higher production and transportation costs. Finally, overall demand in the economy was strong, in part due to aggressive fiscal and monetary policy stimulus measures during the COVID era. Even though there has been at least some improvement in these four factors, inflation can become self-perpetuating if left unchecked. In other words, high inflation can persist even after the initial causes of the inflation have dissipated.
This high rate of inflation would undoubtedly create great long-term damage to the US economy if left unchecked, as was observed in the US in the 1970s and in many other countries over time. Returning inflation to a modest and stable position is and should be a top priority for economic policymakers. As such, the US Federal Reserve (Fed) has worked very aggressively since early-2022 to raise interest rates to suppress overall demand in the economy and therefore reduce inflation. Indeed, the speed at which the Fed has increased rates since March of 2022 has been as aggressive as ever observed over a similar length of time. The fast pace of interest rate increases is partly because the Fed was slow to begin the cycle of interest rate increases due to lingering concerns over new coronavirus variants and outbreaks that continued until early-2022, as well as the unanticipated rapid increases in energy prices in 2022.
Overall, much of the great uncertainty facing the US economy currently stems from the interaction between inflation and these interest rates increases. Indeed, our expectation is that the US economy will follow a path of very slow, albeit positive, economic growth over the next five years overall. In other words, we believe it is possible that the interest rate increases can be timed appropriately such that a broad recession does not develop, and inflation returns to the two percent annual rate that is considered acceptable by the Fed.
However, a much higher-than-normal probability remains that the interest rate increases will prove too detrimental to economic growth and will tip the economy into at least a moderate recession within the next year.
Given this context, in this section we explore a few recent trends in the US economy with special attention paid to inflation and interest rates, and we consider the likely path of growth in the US over the coming five years. These findings have important implications for our discussion of the West Virginia economy in Sections II and III.
National Trends in Output, Employment, and the Labor Market
GDP As illustrated in Figure 1.1, economic output, as measured by real Gross Domestic Product (GDP), fell dramatically in early 2020 due to the outbreak of the COVID-19 pandemic. Likewise, GDP growth was very strong as the economy emerged from the pandemic. Over the course of 2022 and thus far into 2023, in contrast, GDP growth has weakened considerably, and has generally posted year-over-year growth rates that have been below the 30-year average (around 2.3 percent per year), although still in positive territory. The forecast calls for continued growth in real GDP, even though a recession is more likely than normal when considering downside risks. Overall, the pressure that the economy faces from the sharp rise in interest rates is expected to lead to below-average rates of real GDP growth throughout the outlook period.
EMPLOYMENT The US labor market was strong prior to the pandemic, and in fact employment stood at the level that economists generally perceive as the maximum level of jobs the economy can sustain over the long run - termed “full employment.” Over the course of the initial onset of the COVID-19 pandemic, nearly 20 million people in the US lost their jobs. While the US labor market cannot be strictly defined as that of as a “V-shaped recovery,” the rebound in payrolls after the recession was strong enough such that the nation attained its pre-recession level of employment by mid-2022, and employed has continued to growth since then. Overall, the national economy is again at or near its full employment level.
The employment forecast calls for a modest loss in employment over the course of 2024, primarily driven by the lingering effects of the recent interest rate decreases, as discussed above. While some rebound is expected in 2026 through 2028, generally we expect only a negligible amount of employment growth over the outlook period.
UNEMPLOYMENT Turning to the unemployment situation, the national unemployment rate stood at a low of 3.6 percent just before the beginning of the COVID-19 recession, as noted in Figure 1.3. This was one of the lowest jobless rates experienced since the beginning of modern economic statistics. The unemployment rate skyrocketed as the pandemic began, reaching a peak of 13 percent in the Spring of 2020. However, the jobless rate fell rapidly as pandemic-driven lockdowns ended in 2020 and returned to its pre-recession low by early-2022 as hiring activity was consistently strong for that period. Unemployment has remained at this historically low for the last year or more. The forecast calls for a gradual increase in the rate over the next two years, returning the figure close to its natural rate of around 4.5 to 5 percent. This expected increase in the unemployment rate will largely be driven by entry into the labor force, in addition to the modest expected job loss discussed above.
LABOR FORCE PARTICIPATION The labor force participation rate is a complementary measure to the unemployment rate. The labor force participation rate captures the share of the adult population that would like to work—termed “in the labor force”—while the unemployment rate captures the share of the labor force that is unable to find employment in any given month. Ultimately, the labor force participation rate is a more fundamental descriptor of an economy’s long-run labor market situation.
In Figure 1.4 we report labor force participation for the US since the early 1980s. As illustrated, the figure peaked around 2000 at 67 percent, fell substantially after 2008, and then maintained stability up until early-2020. The broad evolution of this figure is largely driven by demographic processes, namely the emergence and aging of “Baby Boom” generation. The figure began to rise substantially around 1965, when the first of the “Baby Boomers” were entering the workforce. This measure continued to rise through the late 1990s, when the first of this group turned 55 years old, but then began to decline substantially around 2008—the point when the leading edge of the Baby Boom approached conventional retirement age. In addition to the baby-boomer effect, the post-WWII structural change in labor force participation rates was driven in large part by meaningful gains in the female labor force that occurred through the mid-1990s.
Labor force participation once again fell substantially because of the COVID-19 recession, as “discouraged workers” left the labor force, reaching a low of just over 60 percent. Immediately after the lockdowns, the figure begun to improve, recovering to over 62 percent. However, the figure remains nearly one percentage point below its pre-COVID level, due primarily to a slower recovery in labor force participation among workers in older age groups (i.e. ages 55 to 64).
Overall, the declines in labor force participation likely present an impediment to the nation’s long-run economic growth potential as fewer workers will be available to support retirees vis-à-vis private pension plans as well as Social Security and other federal programs. Furthermore, many economic challenges below might interact with a lower rate of labor force participation in the long run, leading to a significantly different performance for the US economy over the long term.
INFLATION Next, we turn to inflation – perhaps the most significant problem facing the US economy in the short term. As reported in Figure 1.5, inflation skyrocketed to nearly seven percent on a year-over-year basis in 2021 and 2022, depending upon which reported measure is used. This is the highest rate of inflation experienced in the US since the early-1980s and comes in sharp contrast to the mostly modest inflation that the US experienced for more than two decades, rarely moving outside of the 1 to 3 percent range—a period in economic history referred to as “The Great Moderation.” This sharp rise in inflation was catalyzed by at least four factors: a) high energy prices, in part driven by Russia’s invasion of Ukraine; b) global supply-chain constraints that emerged during the COVID pandemic; c) workforce shortages that emerged during the COVID pandemic; and d) strong aggregate demand, in part driven by aggressive fiscal and monetary stimulus during the COVID era. As described above, even though these drivers have at least partially dissipated, inflation remains a problem as it has the potential to become self-perpetuating if left unchecked. The forecast calls for inflation to remain above the Fed’s target level (two percent) until 2025.
INTEREST RATES This high rate of inflation would undoubtedly create great long-term damage to the US economy if left unchecked, as observed in the US in the 1970s and in many other countries over time. Returning inflation to a modest and stable position is and should be a top priority for economic policymakers. As such, the Fed has worked very aggressively over the course of 2022 and 2023 to raise interest rates to suppress overall demand in the economy and therefore reduce inflation. Indeed, the speed at which the Fed has increased interest rates over the past one- and one-half years has been as aggressive as ever observed over a similar length of time. In retrospect, we understand that the fast pace of interest rate increases is partly because the Fed was slow to begin the cycle of interest rate increases due to lingering concerns over new coronavirus variants/outbreaks that continued until early-2022.
Overall, much of the great uncertainty facing the US economy currently stems from the interaction between inflation and these interest rates increases. It is possible that the rate increases have been timed appropriately such that a broad recession does not develop while inflation also returns to a rate that is considered acceptable (around 2 percent for core inflation, which excludes food and energy from consideration). However, a strong probability exists that the interest rate increases will exert too much downward pressure on demand and will ultimately tip the economy into at least a moderate recession.