Part 1: Recent Economic and Financial Developments

Monetary Policy Report submitted to the Congress on February 19, 2021, pursuant to section 2B of the Federal Reserve Act

Domestic Developments

The labor market has partially recovered from the pandemic-induced collapse, but the pace of improvement slowed substantially toward the end of last year...

The public health crisis spurred by the spread of COVID-19 weighed on economic activity throughout 2020, and patterns in the labor market reflected the ebb and flow of the virus and the actions taken by households, businesses, and governments to combat its spread. During the initial stage of the pandemic in March and April, payroll employment plunged by 22 million jobs, while the measured unemployment rate jumped to 14.8 percent—its highest level since the Great Depression (figures 1 and 2).2 As cases subsided and early lockdowns were relaxed, payroll employment rebounded rapidly—particularly outside of the service sectors—and the unemployment rate fell back. Beginning late last year, however, the pace of improvement in the labor market slowed markedly amid another large wave of COVID-19 cases. The unemployment rate declined only 0.4 percentage point from November through January, while payroll gains averaged just 29,000 per month, weighed down by a contraction in the leisure and hospitality sector, which is particularly affected by social distancing and government-mandated restrictions.

All told, the incomplete recovery left the level of employment in January almost 10 million lower than it was a year earlier, while the unemployment rate stood at 6.3 percent—nearly 3 percentage points higher than before the onset of the pandemic. Most recently, high-frequency data—including initial claims for unemployment insurance and weekly employment data from the payroll processor ADP—suggest modest further improvement in the labor market in recent weeks. (For more discussion of what high-frequency indicators are suggesting about the current trajectory of the economy, see the box "Monitoring Economic Activity with Nontraditional High-Frequency Indicators.")

Monitoring Economic Activity with Nontraditional High-Frequency Indicators

The unprecedented magnitude, speed, and nature of the COVID-19 shock to the economy rendered traditional statistics insufficient for monitoring economic activity in a timely manner. As a result, policymakers around the world turned to nontraditional indicators of activity, both those based on private-sector "big data" and those newly developed by official statistical agencies. Because some of the most salient characteristics of these indicators are their timeliness and the time span they cover (such as daily or weekly), they are often called "high-frequency indicators."

An important example of the usefulness of high-frequency indicators is the case of payroll employment. The Bureau of Labor Statistics' (BLS) monthly measure of payroll employment is one of the most reliable, timely, and closely watched business cycle indicators. However, during the onset of the pandemic in the United States, even the BLS Current Employment Statistics (CES) data were published with too long of a lag to track the dramatic dislocations in the labor market in a timely manner. Specifically, from the second half of March through early April, the economy was shedding jobs at an unprecedented rate, but those employment losses were captured only in the employment situation release issued on May 8, 2020. Because of this lag, economists looked to various private data sources to gain insights about the current state of the labor market.1 An important example is data from the payroll processor ADP that cover roughly 20 percent of private U.S. employment, a sample size similar to the one used by the BLS to construct the CES. Estimates of changes in employment constructed from ADP data have tracked the official CES data remarkably well since the start of the pandemic recession, and the ADP data possess the important benefits of being available earlier and at a weekly frequency (figure A, left panel).2

Weekly employment estimates based on ADP data were particularly valuable not only last spring when employment plummeted and then quickly rebounded, but also during the renewed COVID-19 wave that started this past fall. In particular, high-frequency ADP employment data indicate that the fall and winter virus wave had a smaller effect on the labor market than was seen last spring, likely because there were fewer mandated shutdowns of businesses than in the spring, because many businesses implemented adaptations that made it easier for them to continue to operate (for example, curbside pickup), and because many individuals changed their behavior (for example, by wearing masks such that more economic activities are deemed safer now than in the spring). Most recently, the BLS data show that private payroll employment remained little changed through its survey week in mid-January, and the ADP data indicate that employment improved modestly through early February. Additionally, the latest ADP data indicate that the leisure and hospitality sector—which includes hotels, restaurants, and entertainment venues and is particularly affected by government-mandated restrictions and social distancing—started adding jobs again in recent weeks after experiencing a temporary downturn at the end of last year (figure A, right panel).

Outside of the labor market, several new high-frequency indicators have been useful in monitoring the massive effects of the COVID-19 pandemic on consumer spending. Weekly data from NPD (a market analytics firm) on nonfood retail sales captured in real time the dramatic and sudden drop in consumption in mid-March; the monthly Census Bureau data recorded that decline only with a lag (figure B, left panel).3 The NPD data also reflected how the income support payments to families, provided by the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, rapidly affected consumer spending in mid-April. More recently, the NPD data showed some decline in consumption late last year, followed by a pickup in January after the passage of the most recent fiscal stimulus package. Several nontraditional data sources illustrate that services spending remains depressed as social distancing continues to restrain in-person activity (figure B, right panel).4

With rapid changes in the economic environment, many statistical agencies also developed high-frequency indicators. For example, the Census Bureau released data on weekly new business applications (figure C, left panel). During the initial stage of the pandemic recession, new business applications fell compared with previous years, a typical pattern during economic downturns. However, new business applications started to rebound notably during the summer, and for the year as a whole, they were higher than the average over the previous three years, a pattern that differs dramatically from previous business cycles.5 The increase in applications appears to be concentrated in industries that rapidly adapted to the landscape of the pandemic, such as online retail, personal services, information technology, and delivery. It remains unclear, however, whether these business applications will lead to actual job creation at the same rate as in the past.6 As another example, the Census Bureau developed high-frequency survey statistics that contain information about the financial struggles of households (figure C, right panel). These data indicate that the financial stress of households increased late last year as households were becoming less confident about being able to make their next mortgage or rent payment as well as more likely to expect income loss over the next four weeks, but households' financial expectations improved somewhat in January.

Overall, nontraditional high-frequency indicators have served several purposes over the past year. First, they provide timely alternative estimates that complement official statistics and can also be used to verify movements in official statistics. Second, they are often helpful for assessing economic developments more quickly and with greater granularity than what can be found in official statistics. Third, high-frequency indicators without a direct counterpart in official statistics give a different perspective and help enhance our understanding of economic developments. These nontraditional indicators are also subject to several potential limitations, such as systematic biases due to nonrepresentativeness of data or small (and possibly nonrandom) samples. Importantly, only time will tell if such indicators will continue to provide a signal above and beyond traditional indicators as the high-frequency shocks associated with the pandemic dissipate. Overall, however, the use of nontraditional high-frequency indicators over the past year has amply shown that they can yield large benefits, especially when economic conditions are changing rapidly.

1. See, for example, Raj Chetty, John N. Friedman, Nathaniel Hendren, Michael Stepner, and the Opportunity Insights Team (2020), "The Economic Impacts of COVID-19: Evidence from a New Public Database Built Using Private Sector Data," NBER Working Paper Series 27431 (Cambridge, Mass.: National Bureau of Economic Research, November),; and Alexander W. Bartik, Marianne Bertrand, Feng Lin, Jesse Rothstein, and Matt Unrath (forthcoming), "Measuring the Labor Market at the Onset of the COVID-19 Crisis," Brookings Papers on Economic Activity. Return to text

2. For further analysis of the ADP employment series, see Tomaz Cajner, Leland D. Crane, Ryan A. Decker, John Grigsby, Adrian Hamins-Puertolas, Erik Hurst, Christopher Kurz, and Ahu Yildirmaz (forthcoming), "The U.S. Labor Market during the Beginning of the Pandemic Recession," Brookings Papers on Economic Activity. Note that the ADP employment series referenced in this discussion differ from the ADP National Employment Report, which is published monthly by the ADP Research Institute in close collaboration with Moody's Analytics. Return to text

3. Information from the NPD Group, Inc., and its affiliates contained in this report is the proprietary and confidential property of NPD and was made available for publication under a limited license from NPD. Such information may not be republished in any manner, in whole or in part, without the express written consent of NPD. Return to text

4. Services spending accounts for roughly one-half of aggregate spending, but it is measured with some lag. In particular, the services spending information folded into gross domestic product comes from the revenue information sourced from the Census Bureau's Quarterly Services Survey (QSS). The advance QSS (early data for a subset of industries found in the full QSS) and full QSS are released two and three months, respectively, after a given quarter ends. Return to text

5. For further discussion, see Emin Dinlersoz, Timothy Dunne, John Haltiwanger, and Veronika Penciakova (forthcoming), "Business Formation: A Tale of Two Recessions," American Economic Review Papers and Proceedings. Return to text

6. The link between applications and job creation in the pre-pandemic period is studied in Kimberly Bayard, Emin Dinlersoz, Timothy Dunne, John Haltiwanger, Javier Miranda, and John Stevens (2018), "Early-Stage Business Formation: An Analysis of Applications for Employer Identification Numbers," Finance and Economics Discussion Series 2018-015 (Washington: Board of Governors of the Federal Reserve System, March), Return to text

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. . . and the harm has been substantial

The damage to the labor market has been even more substantial than is indicated by the extent of unemployment alone. The labor force participation rate (LFPR)—the share of the population that is either working or actively looking for work—plunged in March and April, as many of those who lost their jobs were not seeking work and so were not counted among the unemployed. Despite recovering some over the summer, the LFPR remains nearly 2 percentage points below its pre-pandemic level (figure 3). A number of factors appear to have contributed to the continued weakness in the LFPR, including a lack of job opportunities, the effects of school closings and virtual learning on parents' ability to work, the health concerns of potential workers, and a spate of early retirements triggered by the crisis. All told, the employment-to-population ratio—the share of the population with jobs, regardless of the number seeking work—in January was 3.6 percentage points below the level at the beginning of 2020. Job losses last year fell most heavily on lower-wage workers and on Hispanics, African Americans, and other minority groups. As a result, the rise in unemployment and the decline in the employment-to-population ratio were particularly evident among those groups (figure 4). (For more discussion of the pandemic's effects on the labor market outcomes of various groups, see the box "Disparities in Job Loss during the Pandemic.")

Disparities in Job Loss during the Pandemic

Although employment has improved substantially since its trough in April 2020, the labor market recovery remains far from complete: As of January 2021, the employment-to-population (EPOP) ratio, a broad measure that encompasses both increased unemployment and decreased labor force participation, was still 3.6 percentage points below its February 2020 level. All industries, occupations, and demographic groups experienced significant employment declines at the start of the pandemic, and, over the ensuing months, all groups have experienced at least some partial recovery. That said, employment declines last spring were steeper for workers with lower earnings and for Hispanics, African Americans, and other minority groups, and the hardest-hit groups still have the most ground left to regain.

Although disparities in labor market outcomes generally widen during recessions, certain factors unique to this episode—in particular, the social-distancing measures taken by households, businesses, and governments to limit in-person interactions—have profoundly shaped the incidence of recent job losses in different segments of the labor market. Because jobs differ in the degree to which they involve personal contact and physical proximity, in whether they can be performed remotely, and in whether they are deemed to serve "essential" functions, social-distancing measures have had disparate effects across industries and occupations. To illustrate this point, figure A reports net changes in employment in 11 broad industry categories, both during the period of acute job losses last spring (column 1) and over the longer interval since the start of the pandemic (column 2). Net job losses through January have been especially severe in the leisure and hospitality industry—in which employment is still 22.9 percent below pre-pandemic levels (line 11)—and in other services, a category that includes barber shops and beauty salons (line 12).1 By contrast, employment in most other broad industries is now 5 percent or less below pre-pandemic levels. Job losses have thus been disproportionately concentrated in lower-wage consumer service industries, in which business operations are strongly affected by social-distancing measures and relatively few workers are able to work from home.2

A. Changes in private-sector employment, by industry
Industry Percent change since Feb. 2020
(1) As of Apr. 2020 (2) As of Jan. 2021
1. Total private −16.5 −6.6
2. Mining and logging −9.9 −11.7
3. Manufacturing −10.8 −4.5
4. Construction −14.6 −3.3
5. Wholesale trade −6.9 −4.5
6. Retail trade −15.2 −2.5
7. Transp., warehousing, and utilities −9.1 −2.7
8. Information and financial activities −4.8 −2.8
9. Professional and business services −11.1 −3.8
10. Education and health services −11.6 −5.4
11. Leisure and hospitality −48.6 −22.9
12. Other services −23.7 −7.8

Note: The data are seasonally adjusted.

Source: Bureau of Labor Statistics.

In keeping with the sectoral composition of recent job losses, workers in lower-wage jobs have been hit especially hard. Figure B uses data from the payroll processor ADP to plot employment indexes for four job tiers defined by hourly wages. Between February and April of last year, employment fell most sharply for jobs in the bottom quartile of the pre-pandemic wage distribution. Between April and June, employment rose most quickly for these lowest-paying jobs. In subsequent months, job gains moderated substantially for all groups, and as of mid-January, employment in the lowest-paying jobs was about 20 percent below its pre-pandemic level. In comparison, employment in the higher-paying job tiers is now about 10 percent or less below pre-pandemic levels.

Similar disparities are apparent across demographic groups. Figure C shows the change in each group's EPOP ratio. Between February 2020 and January 2021, the EPOP ratio fell by a similar amount for both men and women; in contrast, during many previous recessions the EPOP ratio declined substantially more for men. (In fact, given that men's employment rate was substantially higher than women's before the pandemic, the decline in employment for women as a percentage of pre-recession employment has been larger, which contrasts even more starkly with previous recessions.) Since February 2020, the EPOP ratio has fallen more for people without a bachelor's degree than for those with at least a bachelor's degree, more for prime-age individuals than for those under age 25 or over age 55, and more for Hispanics, African Americans, and Asians than for whites.3 In general, the groups experiencing the largest declines in employment since last February are more commonly employed in the industries that have experienced the greatest net employment declines to date, such as leisure and hospitality; these demographic groups are also less likely to report being able to work from home.4

Since the start of the pandemic, another important impediment to individuals' ability to work or look for work has been the absence of in-person education for many K–12 students.5 Because many working parents are unable to work from home while monitoring their children's virtual education (depending on the nature of their jobs and the availability of other caregivers), the widespread lack of K–12 in-person education may also explain some of the differences across groups. For example, among mothers aged 25 to 54 with children aged 6 to 17, the fraction who said they are not working or looking for work for caregiving reasons was 2-1/2 percentage points higher in the three months ending January 2021 than over the year-earlier period, compared with a 1/2 percentage point increase for fathers. Relative to white mothers, the increase was about twice as large for Hispanic mothers and more than twice as large for African American mothers, and it was also more than twice as large for mothers without any college education as for mothers with more education.6

As the spread of COVID-19 is contained and a growing share of the population is immunized, some of the unique factors that have exacerbated disparities since the start of the pandemic will likely ease. For example, as COVID becomes less prevalent, businesses offering in-person services (for example, in the leisure and hospitality industry) will move closer to pre-pandemic levels of employment. In addition, as more schools return to offering in-person education, childcare constraints will become less acute.

Even as labor market impediments specific to the pandemic subside, however, the speed at which the labor market moves toward full employment will be important for narrowing the disparities that have widened since the start of the pandemic, as research has consistently shown that strong labor markets especially benefit lower-wage and disadvantaged workers.7 The pace of labor market gains will also depend on how many unemployed workers have the opportunity to return to their original jobs. In January 2021, 2.2 percent of labor force participants (representing 34.6 percent of unemployed workers) reported being unemployed because of a permanent job loss, up from 1.3 percent of the labor force (8.8 percent of unemployed workers) in April 2020.8 Research has shown that workers who return to their previous employers after a temporary layoff tend to earn wages similar to what they were making previously, whereas laid-off workers who do not return to their previous employer experience a longer-lasting decline in earnings.9

1. Net job losses have also been pronounced in mining and logging (line 2), which is unique among these industries in having experienced further contraction in employment between April 2020 and January 2021. Return to text

2. For instance, in the January 2021 round of the Current Population Survey, 41 percent of those employed in the professional and business services industry reported working from home during the previous four weeks as a result of the pandemic, compared with about 7 percent of those employed in leisure and hospitality. See Bureau of Labor Statistics (2021), "Supplemental Data Measuring the Effects of the Coronavirus (COVID-19) Pandemic on the Labor Market," Current Population Survey, January, Return to text

3. The decline in employment also appears to have been relatively large for Native Americans, based on annual average data for 2020. (Monthly data are not available for this group because of small sample sizes and are not shown in figure C for that reason.) Return to text

4. For more information on the groups with the largest employment declines since February 2020, see Kenneth A. Couch, Robert W. Fairlie, and Huanan Xu (2020), "Early Evidence of the Impacts of COVID-19 on Minority Unemployment," Journal of Public Economics, vol. 192 (December), pp. 1–11; Guido Matias Cortes and Eliza C. Forsythe (2020), "The Heterogeneous Labor Market Impacts of the Covid-19 Pandemic," Upjohn Institute Working Paper Series 20-327 (Kalamazoo, Mich.: W.E. Upjohn Institute for Employment Research, May),; and Titan Alon, Matthias Doepke, Jane Olmstead-Rumsey, and Michèle Tertilt (2020), "This Time It's Different: The Role of Women's Employment in a Pandemic Recession," NBER Working Paper 27660 (Cambridge, Mass.: National Bureau of Economic Research, August),
Additional details on differences across demographic groups in the ability to work from home can be found in the Current Population Survey. For example, in January, around 23 percent of white workers reported working from home in the previous four weeks because of the pandemic, compared with 19 percent of African Americans and 14 percent of Hispanics; 43 percent of those with a bachelor's degree or higher reported working from home, compared with 16 percent or less for those with lower levels of education. See Bureau of Labor Statistics, "Supplemental Data," in box note 2. Return to text

5. According to the Census Bureau's Household Pulse Survey, 85 percent of parents surveyed in early January reported that their children's classes for the 2020–21 school year were moved to virtual learning. Return to text

6. The findings are Federal Reserve Board staff estimates based on publicly available Current Population Survey microdata. Return to text

7. For example, see Stephanie R. Aaronson, Mary C. Daly, William L. Wascher, and David W. Wilcox (2019), "Okun Revisited: Who Benefits Most from a Strong Economy?" Brookings Papers on Economic Activity, Spring, pp. 333–75,; and Tomaz Cajner, Tyler Radler, David Ratner, and Ivan Vidangos (2017), "Racial Gaps in Labor Market Outcomes in the Last Four Decades and over the Business Cycle," Finance and Economics Discussion Series 2017-071 (Washington: Board of Governors of the Federal Reserve System, June), Return to text

8. The data are Federal Reserve Board staff calculations from published Bureau of Labor Statistics estimates. By comparison, the number of permanent job losers peaked at 4.4 percent of labor force participants (representing 44.8 percent of unemployed workers) during the Great Recession. Return to text

9. See Louis S. Jacobson, Robert J. LaLonde, and Daniel G. Sullivan (1993), "Earnings Losses of Displaced Workers," American Economic Review, vol. 83 (September), pp. 685–709; Shigeru Fujita and Giuseppe Moscarini (2017), "Recall and Unemployment," American Economic Review, vol. 107 (December), pp. 3875–916; and Marta Lachowska, Alexandre Mas, and Stephen A. Woodbury (2020), "Sources of Displaced Workers' Long-Term Earnings Losses," American Economic Review, vol. 110 (October), pp. 3231–66. Return to text

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Aggregate wage growth appears to be little changed despite the weakness in the labor market

Although weakness in the labor market generally puts downward pressure on overall wages, the best available measures suggest that wage growth in 2020 was little changed from 2019. Total hourly compensation as measured by the employment cost index, which includes both wages and benefits, rose 2.6 percent during the 12 months ending in December, only slightly below pre-pandemic rates (figure 5). Wage growth as computed by the Federal Reserve Bank of Atlanta, which tracks the median 12-month wage growth of individuals responding to the Current Population Survey, was about 3-1/2 percent during 2020, similar to the growth rate in 2019.3 The continued gains in aggregate wages mask important heterogeneity, however; according to the Atlanta Fed data, workers with lower earnings and nonwhites experienced larger decelerations in wages than other groups last year.

Price inflation remains low despite rebounding since last spring

As measured by the 12-month change in the price index for personal consumption expenditures (PCE), inflation fell from 1.6 percent in December 2019 to a low of 0.5 percent in April, as economic activity dropped sharply (figure 6). Since then, inflation has partially recovered along with the pickup in demand, but it was only 1.3 percent in December—still well below the Federal Open Market Committee's (FOMC) objective of 2 percent. After excluding consumer food and energy prices, which are often quite volatile, the 12-month measure of core PCE inflation was 1.5 percent in December. An alternative way to abstract from transitory influences on measured inflation is provided by the trimmed mean measure of PCE price inflation constructed by the Federal Reserve Bank of Dallas.4 The 12-month change in this measure declined to 1.7 percent in December from 2 percent a year earlier, a similar decrease to those in total and core PCE inflation.

The low level of consumer price inflation in 2020 partly reflected the deterioration in economic activity. For example, inflation in tenants' rent and owners' equivalent rent, which tend to be sensitive to overall economic conditions, softened in 2020 from the rates observed during the preceding few years. Low inflation also reflected the net effect of a number of pandemic-driven shifts in specific sectors of the economy, such as a decline in gasoline prices that resulted from a collapse in oil prices in the early part of the year, which only partially reversed in the second half. Similarly, airfares and hotel prices fell markedly, driven by huge reductions in demand due to the pandemic. In contrast, food prices increased at an unusually fast pace last year, given stronger demand at retail grocery stores and, at times, some pandemic-related supply chain disruptions. In addition, prices for some durable goods, such as motor vehicles and home appliances, rose sharply during the summer and remained somewhat elevated at the end of the year, in part because of a pandemic-induced shift in demand away from services and toward these goods.

Prices of imports and oil have also rebounded

The partial rebound in inflation later in 2020 also stemmed from a firming of import prices. After declining in the first half of last year, nonfuel import prices increased in the second half, as the dollar depreciated and the recovery in global demand put upward pressure on non-oil commodity prices—a substantial component of nonfuel import prices (figure 7). Prices of both agricultural commodities and industrial metals increased considerably, and nonfuel import prices are now higher than they were a year ago.

Early in the pandemic, benchmark oil prices fell below $20 per barrel, a level not breached since 2002. While prices have now nearly recovered, oil consumption and production are still well below pre-pandemic levels (figure 8). Although global economic activity has picked up since last spring, oil demand has not fully recovered, held back by the slow recovery in travel and commuting. Weak demand has been met by reductions in supply: U.S. production has fallen dramatically relative to a year ago, while OPEC (Organization of the Petroleum Exporting Countries) and Russia have only slightly increased production after making sharp cuts last spring.

Survey-based measures of long-run inflation expectations have been broadly stable...

Despite the volatility in actual inflation last year, survey-based measures of inflation expectations at medium- and longer-term horizons, which likely influence actual inflation by affecting wage- and price-setting decisions, have been little changed on net (figure 9). In the University of Michigan Surveys of Consumers, the median value for inflation expectations over the next 5 to 10 years was 2.7 percent in January and early February. In the Survey of Consumer Expectations, conducted by the Federal Reserve Bank of New York, the median of respondents' expected inflation rate three years ahead was 3.0 percent in January, somewhat above its year-earlier level. Finally, in the first-quarter Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, the median expectation for the annual rate of increase in the PCE price index over the next 10 years was 2.0 percent, close to the level around which it had typically hovered in previous years.

. . . and market-based measures of inflation compensation have retraced earlier declines

Inflation expectations can also be inferred from market-based measures of inflation compensation, although the inference is not straightforward because these measures are affected by changes in premiums that provide compensation for bearing inflation and liquidity risks. Measures of longer-term inflation compensation—derived either from differences between yields on nominal Treasury securities and those on comparable-maturity Treasury Inflation-Protected Securities (TIPS), or from inflation swaps—dropped sharply last March, partly reflecting a reduction in the relative liquidity of TIPS compared with nominal Treasury securities (figure 10). Both measures rebounded in the next couple of months as liquidity improved, before drifting up further through the remainder of 2020 and early 2021. The TIPS-based measure of 5-to-10-year-forward inflation compensation and the analogous measure from inflation swaps are now about 2-1/4 percent and 2-1/2 percent, respectively, a bit above the average levels seen in 2019.5

The plunge and rebound in gross domestic product reflected unusual patterns of spending during the pandemic

After contracting with unprecedented speed and severity in the first half of 2020, gross domestic product (GDP) rose rapidly in the third quarter and continued to pick up, albeit at a much slower pace, in the fourth quarter (figure 11). The rebound in activity reflected a relaxation of voluntary and mandatory social distancing, as well as unprecedented fiscal and monetary support. Nevertheless, the recovery remains incomplete: At the end of 2020, GDP was 2.5 percent below its level four quarters earlier. This incomplete recovery reflected weakness in services consumption and overall exports that resulted largely from ongoing social-distancing measures to contain the virus, both at home and abroad. The concentration of the recession in services is unprecedented in the United States. Indeed, the sectors that are typically responsible for the cyclical dynamics of GDP have shown remarkable resilience: Activity in the housing market and consumer spending on goods were both above their pre-pandemic levels in the fourth quarter, and business fixed investment and manufacturing output also recovered rapidly from their initial plunges.

Consumer spending, particularly on goods, bounced back in the second half of 2020...

Household consumption rebounded rapidly during the late spring and summer from its COVID-induced plunge, and it continued to make gains through the fourth quarter, ending the year 2.6 percent below its year-earlier level. Notably, purchases of both durable and nondurable goods rose above their pre-COVID levels in the second half of 2020, as spending shifted away from services curtailed by voluntary and mandatory social distancing (figure 12). Within durable goods, sales of light motor vehicles moved up quickly in the second half and are now close to their pre-pandemic level; any residual weakness in sales may be attributable to low supply, as production has failed to keep pace with demand. Services spending also rebounded from the extraordinarily low level seen in April, but it remained well below its pre-pandemic pace through the fourth quarter, as concerns about the virus continued to limit in-person interactions. Notably, consumer sentiment has also remained well below pre-pandemic levels (figure 13).

. . . assisted by government income support...

Consumer spending has been bolstered by government income support in the form of unemployment insurance and stimulus measures targeted at households. These payments were largest in the spring and summer of last year, but even in the fourth quarter aggregate real disposable personal income (DPI) was 3.7 percent above the level prevailing in late 2019, despite the low level of employment.6 The still-elevated level of DPI, combined with the low level of consumption, resulted in an aggregate saving rate of more than 13 percent in the fourth quarter, nearly double its level from a year earlier (figure 14).7 That said, these aggregate figures mask important variation across households, and many low-income households, especially those whose earnings declined as a result of the pandemic and recession, have seen their finances stretched.8

. . . but spending fell back late in the year

As COVID cases began rising again in November, some states retightened restrictions, and many households likely cut back voluntarily on their activities, leading to a retrenchment in spending on services such as restaurants and travel. Spending on durable goods also stepped down late in the fourth quarter, possibly in part because many households had already purchased durable items such as furniture and electronics earlier in the year. Further, while higher-income households accrued substantial savings over the course of 2020, some lower-income consumers likely began to reduce their spending toward the end of the year, as support provided by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) waned. More recently, however, retail sales data and high-frequency indicators suggest that consumer spending rose appreciably in January, likely in part because of additional fiscal support from the Consolidated Appropriations Act, 2021, which was enacted in late December.

Soaring equity and house prices have pushed aggregate household wealth to record highs

Stock markets rallied after plunging in the spring and, more recently, have reached record highs, largely reflecting the arrival of effective vaccines, optimism about further fiscal stimulus, and notable improvement in the outlook for corporate earnings. House prices—which are of particular importance for the value of assets held by many households—have also soared, boosted by strong demand from record-low mortgage rates, a shift in demand from multifamily to single-family homes during the pandemic, and a shortage of inventory (figure 15). As a result, aggregate household wealth is elevated relative to income, which is supporting consumption, particularly of relatively well-off households (figure 16).

Lending standards for households are less accommodative than before the pandemic, but credit is still available to households with good credit profiles

Consumer lending standards remain less accommodative than before the pandemic, on balance, and are particularly tight for individuals with low credit ratings. Banks tightened lending standards substantially in the first half of 2020, but the tightening moderated in the second half and credit remains available to higher-score borrowers. Banks also reported considerably weaker demand for consumer credit on balance. Credit card lending volumes have been weak, consistent with the incomplete recovery in overall consumer spending, but auto lending has been stronger amid the rapid recovery in motor vehicle sales to consumers (figure 17). Mortgage lending has also been robust, boosted both by record-low mortgage interest rates and by mortgage credit that is generally available to those with good credit scores who are seeking traditional mortgage products (figure 18). Overall, loan defaults have remained low despite the weak labor market, supported by various forbearance programs.

The housing sector made a remarkable recovery in the second half of 2020...

Residential investment grew at a robust pace of 14 percent over the four quarters of 2020, as booming home sales and housing construction in the second half more than offset the outsized declines in the second quarter that resulted from the COVID-19 outbreak and mitigation efforts. Historically low mortgage rates and the swift adaptation of the real estate sector to the pandemic boosted housing activity later in the year, with both single-family housing starts and existing home sales rising to their highest levels since the mid-2000s (figures 19 and 20).9 The burst of housing demand has left inventories of both new and existing homes at all-time lows, putting upward pressure on home prices and supporting new construction. Some of these patterns in the data likely reflect changes in preferences during the pandemic, with households opting for larger homes and housing in less dense areas, but the degree to which these changes will persist remains unclear.

. . . and business fixed investment also rebounded rapidly...

Business fixed investment—that is, private expenditures for equipment, structures, research and development, and other intellectual property—contracted sharply in the first half of 2020 but largely retraced its decline in the second half. The recovery in business investment has been centered in equipment and intellectual property, which rose 2.4 percent over the four quarters of 2020, supported by stronger business sentiment, improved financing conditions, and the unwinding of direct disruptions from social distancing (figure 21). In addition, the health crisis and the shift to widespread teleworking have led to a surge in investment in both medical equipment and computers. In contrast, investment in nonresidential structures continued to decline sharply in the second half. Drilling investment was particularly hard hit and fell 30 percent in 2020 as a result of declines in energy demand and oil prices. Investment in nondrilling structures also fell, although more moderately. Long build times imply that the decline in new construction projects started in the first half of 2020 led to less ongoing spending in the second half; moreover, firms likely remain uncertain about future demand for many types of structures in the wake of the pandemic.

. . . amid notable improvements in corporate financing conditions

Financing conditions for nonfinancial firms through capital markets have improved notably since June. In particular, interest rates have remained very low and corporate bond spreads have narrowed. Gross issuance of nonfinancial corporate bonds was solid in the second half of the year, although it slowed from the exceptional pace in the second quarter (figure 22). In contrast, aggregate bank lending to businesses contracted in the second half, reflecting lower demand for new loans, the repayment of outsized draws on credit lines earlier this year, the forgiveness of some loans under the Paycheck Protection Program, and tighter bank credit standards. In part because of policy actions to foster smooth market functioning, corporations have been able to take advantage of favorable funding conditions in capital markets to refinance debt and bolster their balance sheets; as a result, corporate cash holdings are at record levels. In the small business sector, privately financed lending also picked up over the summer, and loan performance improved, supported by the Paycheck Protection Program. Nevertheless, credit availability for small businesses remains fairly tight, demand for such credit is weak, and default risk is still elevated.

Exports remain lower, but imports have recovered

U.S. exports remain well below pre-pandemic levels. With many foreign economies still weak, U.S. exports of goods have not quite fully recovered from their earlier sharp declines, while exports of services remain depressed because of the continued suspension of most international travel. In contrast, imports have regained most of their lost ground. Reduced imports of services have been offset by a full rebound of goods imports, which reflects strong U.S. demand for household goods (figure 23). Both the nominal trade deficit and current account deficit, relative to GDP, widened since 2019 (figure 24).

Federal fiscal stimulus provided substantial support to economic activity while also significantly boosting the budget deficit and debt

Federal fiscal policy measures enacted in response to the pandemic continue to provide crucial income support to households and businesses, as well as grants-in-aid to state and local governments. These measures have also facilitated loans to businesses, households, states, and localities.10 In total, the Congressional Budget Office projects that in fiscal years 2020 and 2021, the additional federal government expenditures and foregone revenues from these policies will total roughly $3 trillion—around 15 percent of nominal GDP.11 In addition, the decline in economic activity has pushed down tax receipts while pushing up outlays for certain transfer programs—most notably for unemployment insurance and Medicaid (figure 25). These tax decreases and transfer increases (referred to as automatic stabilizers) worked in tandem with the discretionary stimulus to support aggregate demand and blunt the extent of the economic downturn.

The combination of the discretionary stimulus measures and the automatic stabilizers caused the budget deficit in fiscal 2020 to rise to 15 percent of nominal GDP—the largest deficit as a share of GDP in the post–World War II era—up from its already elevated level of 4-1/2 percent in fiscal 2019. Consequently, the ratio of federal debt held by the public to nominal GDP rose from 79 percent in fiscal 2019 to 100 percent by the end of fiscal 2020, the highest debt-to-GDP ratio since 1947 (figure 26). Even so, the cost of servicing the federal debt is not particularly elevated by historical standards, because Treasury rates are extremely low.

State and local governments are facing challenging fiscal conditions

State and local governments are confronting challenging budget conditions because of weak tax collections and extraordinary expenses related to the pandemic. Nominal state government tax collections in 2020 were about 1 percent below their 2019 level and well below levels generally expected before the pandemic (figure 27).12 The magnitude of these revenue shortfalls varied considerably across states, with the largest shortfalls in states that rely heavily on sales taxes, tourism, and energy production. In contrast, property taxes—the principal local government tax—have continued to rise apace, and state and local governments have received federal aid that has assisted with COVID-related expenses and helped ease budget strains. Meanwhile, bond market conditions for state and local governments have been generally accommodative in the second half of the year, as robust municipal bond issuance has been supported by historically low yields and tax-exempt municipal bond funds have seen solid inflows. Even so, in response to social-distancing restrictions (including virtual learning), current budget pressures, and concerns over future budgetary challenges, state and local governments have cut payrolls—particularly in the education sector—an unprecedented 6-1/2 percent over the past year (figure 28). Notably, public-sector employment is down significantly in nearly all states, including those that have experienced relatively smaller revenue shocks.

Vaccines offer hope of an end to the pandemic, but risks to the outlook are still substantial

The economic outlook presented in Part 3 depends crucially on the course of the COVID-19 pandemic. The vaccination campaign now under way offers the prospect of a return to more normal conditions by the end of this year. But the pace of vaccinations, the rate of decline in the spread of the virus, and the speed with which people return to normal activities all remain highly uncertain, particularly given the emergence of new, apparently more contagious strains. The longer-run economic effects of the pandemic are also difficult to predict. Many small businesses have shut down and may not reopen. Some pandemic-driven shifts in economic activity, such as from in-person to online shopping and from office-based to remote work, may prove to be permanent. These shifts could increase productivity by substituting remote interactions for costly travel and commuting, but they could also put persistent upward pressure on unemployment, as affected workers may need to seek new jobs and perhaps new occupations. The pandemic has also disrupted schooling at all levels, which could have persistent negative effects on educational attainment and economic outcomes for affected students.

Financial Developments

The expected level of the federal funds rate over the next few years has remained near zero

Economic forecasters and financial market participants expect the federal funds rate over the next several years to remain at the effective lower bound. Market-based measures of federal funds rate expectations over the next few years have increased moderately since June and remain below 0.25 percent until the second quarter of 2023 (figure 29).13 According to the results of the Survey of Primary Dealers and the Survey of Market Participants, both conducted by the Federal Reserve Bank of New York in January, the median respondent views the most likely path of the federal funds rate as remaining in its current range of 0 to 1/4 percent until the first half of 2024.14

Yields on longer-term U.S. nominal Treasury securities increased markedly...

Yields on nominal Treasury securities at longer maturities increased markedly since mid-2020 after falling sharply in late February and early March as investors' concerns regarding the implications of the COVID-19 outbreak for the economic outlook led to both falling policy rate expectations and flight-to-safety flows (figure 30). The increase in yields on longer-term Treasury securities followed news of the imminent arrival of multiple highly effective COVID-19 vaccines in the fall of 2020 and expectations of further fiscal support, as well as an increase in the issuance of longer-term Treasury securities. Near-term uncertainty about longer-dated nominal Treasury yields—as measured by volatility of near-term swaptions of 10-year interest rates—has remained low.

. . . while spreads of other long-term debt to Treasury securities narrowed...

Despite the rise in Treasury yields, yields on 30-year agency mortgage-backed securities (MBS)—an important determinant of mortgage interest rates—decreased somewhat, on balance, amid the Federal Reserve's ongoing purchases of MBS and have remained near their historical lows (figure 31). Thus, the spread between yields on 30-year agency MBS and comparable-maturity Treasury yields has narrowed.

Approval of the effective vaccines late last year, optimism about further fiscal support, and notable improvement in the outlook for corporate earnings boosted investors' optimism, and improvement in the credit quality of firms drove declines in yields on investment- and speculative-grade corporate bonds (figure 32). As with mortgage securities, spreads on corporate bond yields over comparable-maturity nominal Treasury yields have narrowed considerably since the end of June—as corporate bond yields declined and yields on nominal Treasury securities increased—and have returned to levels observed before the pandemic. Yields on municipal debt continued to decline in the second half of 2020, and spreads on municipal bonds over comparable-maturity nominal Treasury yields have narrowed substantially since the end of June, as nominal Treasury yields increased and investors grew more optimistic about further fiscal stimulus and aid to state and local governments. The year-end expiration of lending facilities that were authorized under section 13(3) of the Federal Reserve Act and that use CARES Act funding did not lead to upward pressure on corporate or municipal bond spreads.

. . . and market functioning for Treasury securities, corporate bonds, mortgage-backed securities, and municipal bonds continued to improve...

After having improved substantially in the spring of last year, measures of market liquidity for Treasury securities—such as measures of market depth and trade sizes—continued to improve somewhat in the second half of 2020 and moved closer to pre-pandemic levels, especially for shorter-dated Treasury securities. However, measures of liquidity for longer-dated Treasury securities and in some portions of the MBS market—notably for those securities excluded from Federal Reserve open market purchases—remained somewhat below pre-pandemic levels. Measures of market functioning of the corporate bond market continued to improve as bid-ask spreads narrowed considerably and returned to their pre-pandemic levels and issuance of corporate bonds in primary markets was robust. Measures of market functioning of the municipal bond market—such as robust issuance of municipal bonds in primary markets and round-trip transaction costs—indicate that market conditions remained stable in the second half of 2020.

. . . while conditions in short-term funding markets remained stable

The effective federal funds rate and other secured and unsecured short-term rates continued to trade within the target range of the federal funds rate, as ample liquidity, primarily due to substantial increases in reserves, has kept markets functioning smoothly. Since June, measures of stress in short-term funding markets—including trading volumes, issuance, and spreads to overnight index swaps—have remained stable at or near pre-pandemic levels, and year-end funding pressures were minimal.

Broad stock prices have risen notably

After starting to rebound last spring from their COVID-related declines, broad stock prices have risen notably further since mid-2020, as the arrival of effective vaccines, optimism about further fiscal support, and notable improvement in the outlook for corporate earnings outweighed investor concerns regarding the rise in COVID-19 cases (figure 33). The prospect of an economic recovery aided by effective vaccines and fiscal support led to outsized price gains in some cyclical sectors, such as the consumer discretionary, materials, and information technology sectors. Similarly, stock prices of smaller corporations considerably outperformed large-cap stock price indexes. After experiencing depressed levels through early fall, bank stock price indexes increased considerably in late 2020, boosted by positive vaccine news, a generally improved investor outlook for loan losses and bank profitability, and the release of favorable stress-test results in late 2020. Measures of realized and implied stock price volatility for the S&P 500 index—the 20-day realized volatility and the VIX—decreased sharply from their very high levels at the end of the second quarter but remained moderately above their historical medians, respectively (figure 34). (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability.")

Developments Related to Financial Stability

This discussion reviews vulnerabilities in the U.S. financial system since the COVID-19 outbreak and summarizes recent actions and developments at facilities established by the Federal Reserve to support the flow of credit throughout the economy.1 The framework used by the Federal Reserve Board for assessing the resilience of the U.S. financial system focuses on financial vulnerabilities in four broad areas: asset valuations, business and household debt, leverage in the financial sector, and funding risks.

Overall, asset valuation pressures, which were elevated before the COVID-19 outbreak in the United States, briefly subsided at the onset of the outbreak as asset prices plummeted but have since retraced in most markets. In particular, prices in equity, corporate bond, and residential real estate (RRE) markets have returned to or exceeded pre-pandemic levels, buoyed in part by recent developments related to vaccines. Equity prices have more than recovered from the steep declines at the onset of the pandemic, with investor appetite broadly rebounding across most sectors. Equity market volatility remains high, indicating persistent uncertainty regarding the pandemic and the related course of economic activity. Yields on corporate bonds over comparable-maturity Treasury securities have narrowed considerably. Treasury yields across the maturity spectrum declined at the onset of the pandemic and remain near historical lows. The credit quality of outstanding leveraged loans deteriorated early this year, but investor appetite remains strong and new issuance has increased in the second half of 2020. RRE prices also rose rapidly in the second half of 2020, outpacing rent increases. Commercial real estate prices remain at historically high levels despite high vacancy rates and appear susceptible to sharp declines, particularly if the pace of distressed transactions picks up or, in the longer term, the pandemic leads to permanent changes in demand.

Vulnerabilities associated with business and household debt increased over the course of 2020. Business debt has risen from levels that were already elevated before the outbreak of the pandemic. Business leverage now stands near historical highs. While near-term risks associated with debt service may be limited by large cash balances at large firms, low interest rates, and recently improved earnings prospects, insolvency risks at small and medium-sized firms, as well as at some large firms, remain considerable. The household sector entered the downturn with relatively low debt but experienced significant financial strains because of the unprecedented spike in unemployment and business closures. Government programs—including expanded unemployment insurance and direct stimulus payments in the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act—and a rebound in economic activity in the second half of 2020 reduced economic hardship for households and mitigated the deterioration in household credit quality.

In the financial sector, bank profitability and capital positions, which were strained by the outbreak of the pandemic, improved in the second half of 2020 because of a combination of lower-than-expected losses, a better economic outlook, and restrictions imposed by the Federal Reserve on capital distributions by the largest banks. In particular, the capitalization of U.S. global systemically important banks, or G-SIBs, exceeds pre-pandemic levels. In addition, the results of stress tests released in June and December 2020 indicated that banks would generally remain well capitalized under extremely severe recession scenarios. Leverage at broker-dealers changed little over 2020 and remains at historically low levels. While the liquidity deterioration across dealer-intermediated markets in March 2020 demonstrated potential fragility despite dealers' low leverage, this fragility has been likely mitigated by emergency lending facilities and the supervisory action of the Federal Reserve. By contrast, leverage at life insurance companies has risen to post-2008 highs. Vulnerabilities from leverage at hedge funds remain elevated. Finally, securitization volumes increased after coming to a halt in March 2020 but remain significantly below pre-pandemic levels.

Over the course of 2020, banks relied only modestly on short-term wholesale funding and maintained significant levels of high-quality liquid assets. By contrast, developments at the onset of the pandemic demonstrated significant structural vulnerabilities at money market mutual funds and open-end investment funds, particularly those that invest substantially in corporate and municipal debt. These funds experienced large, sudden redemptions in March 2020, which contributed to strains in broader short-term funding markets and fixed-income debt markets. Federal Reserve actions, including emergency lending facilities, have mitigated these vulnerabilities for now, but without structural reforms, the vulnerabilities demonstrated in March 2020 will persist and could significantly amplify future shocks.

The outlook for the pandemic and economic activity remains uncertain globally. In response to the economic disruptions caused by the pandemic, many foreign governments have ramped up spending to support households and businesses. Nevertheless, financial systems in some foreign economies are more vulnerable than before the pandemic, and these vulnerabilities may grow in the near term. Risks from widespread and persistent stresses in emerging markets and dollar funding markets could interact with risks associated with the course of COVID-19 for the U.S. financial system. In turn, these risks could be amplified by the vulnerabilities identified in this discussion and produce additional strains for the U.S. financial system and economic activity.

Developments Associated with Facilities to Support the Economy during the COVID-19 Crisis

In the immediate wake of the pandemic, the Federal Reserve took forceful actions and established emergency lending facilities, with the approval of the Secretary of the Treasury as needed. These actions and facilities have supported the flow of credit to households and businesses and have served as backstop measures that have given investors confidence that support will be available should conditions deteriorate substantially.

Some of the facilities established at the onset of the pandemic are still operational. The Commercial Paper Funding Facility (CPFF), the Money Market Mutual Fund Liquidity Facility (MMLF), and the Primary Dealer Credit Facility (PDCF) stabilized short-term funding markets and improved the flow of credit to households and businesses. Although balances in the PDCF, CPFF, and MMLF have fallen from their initial highs to low levels, the facilities will continue to serve as important backstops against further market stress until their scheduled expiration at the end of March 2021. The Paycheck Protection Program Liquidity Facility (PPPLF) was established to extend credit to lenders that participate in the Paycheck Protection Program of the Small Business Administration (SBA), which has provided payroll support for small businesses. Through mid-January 2021, the Federal Reserve has made nearly 15,000 PPPLF advances to more than 850 banking institutions, totaling more than $110 billion in liquidity.

The Federal Reserve has taken actions that reduce spillovers to the U.S. economy from foreign financial stresses. Temporary U.S. dollar liquidity swap lines were established in March 2020, in addition to the preexisting standing lines, and have improved liquidity conditions in dollar funding markets in the United States and abroad by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions during times of market stress. The FIMA (Foreign and International Monetary Authorities) Repo Facility has helped support the smooth functioning of the U.S. Treasury market by providing a temporary source of U.S. dollars to a broad range of countries, many of which do not have swap line arrangements with the Federal Reserve. The temporary swap lines and the FIMA Repo Facility will continue to serve as liquidity backstops until their scheduled expiration at the end of September 2021.

Other facilities established at the onset of the pandemic expired either at the end of December 2020 or at the beginning of January 2021. The Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility, and the Municipal Liquidity Facility were established to improve the flow of credit through bond markets, where large firms and municipalities obtain most of their long-term funding. The Term Asset-Backed Securities Loan Facility was also set up to support the issuance of securities backed by student loans, auto loans, credit card loans, loans backed by the SBA, and certain other assets. Altogether, before expiring at the end of 2020, these facilities brought rapid improvements to credit markets, with only modest direct interventions. The Main Street Lending Program (Main Street) expired at the beginning of January 2021. In its period of operation, Main Street purchased about 1,800 loan participations, totaling more than $16 billion, which helped small and medium-sized businesses from some of the hardest-hit areas of the country and covered a wide range of industries.

1. The Financial Stability Report published in November 2020 presents the most recent, detailed assessment of U.S. financial system vulnerabilities and a summary of Federal Reserve actions and developments at facilities during the COVID-19 crisis. See Board of Governors of the Federal Reserve System (2020), Financial Stability Report (Washington: Board of Governors, November), Return to text

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Bank credit contracted, while bank profitability improved

In contrast with strong debt issuance through securities markets, outstanding bank loan balances across most major loan categories have contracted since mid-June amid generally weak borrower demand and tight lending standards. Commercial and industrial (C&I) loans at banks declined sharply in the second half of 2020, reflecting the repayment of large credit-line draws made earlier in the year and the forgiveness of some loans under the Paycheck Protection Program, as well as generally weak borrower demand for such loans and tighter bank lending standards. However, overall C&I loan balances at banks remained higher compared with a year earlier (figure 35). Measures of bank profitability, such as return on assets and return on equity, rebounded in the second half of 2020 following very low readings in the second quarter, when banks significantly increased their loan loss provisions, but have remained below pre-pandemic levels (figure 36). Delinquency rates on bank loans remained low, as banks' loss-mitigation and forbearance programs allowed many borrowers to stay current on their loans. Large banks posted higher-than-expected earnings in the fourth quarter, bolstered by capital market activity and loan loss reserve releases, while low rates continued to weigh on profit margins.

International Developments

Economic activity abroad snapped back in the third quarter...

As in the United States, foreign GDP partially rebounded in the third quarter of 2020 (figure 37). Nonetheless, foreign economic activity remains well below its pre-pandemic level, as a resurgence of infections in many economies has recently led to renewed social-distancing restrictions. The accompanying slowdown in economic activity appears to have been less dramatic than that in the spring, as economies have adjusted to function better under social-distancing restrictions. In addition, many current containment measures have been less stringent relative to those in the spring, and fiscal and monetary policies continue to support the path to recovery.

Since last spring, manufacturing has generally recovered more than services, which remain depressed because consumers have avoided socially intensive activities, especially in the hospitality and leisure sectors (figure 38). Some higher-income Asian economies, where infections are more under control, experienced relatively better GDP growth than many advanced economies and benefited from increased export demand in the second half of 2020. Most notably, China's GDP was 6.5 percent higher in the fourth quarter of 2020 compared with a year ago. In many Latin American countries and advanced foreign economies (AFEs), fourth-quarter GDP contracted relative to a year earlier (figure 39).

Although the ongoing spread of the virus—including new variants—is concerning, many AFEs have already started immunizing their populations and have commitments to purchase substantial stocks of vaccines. Controlling the virus globally, however, will be challenging, in part because many emerging market economies (EMEs) have more limited access to vaccines and face greater distribution challenges.

. . . with considerable policy support and subdued inflation

Efforts to contain the virus's resurgence in the fourth quarter prompted some foreign central banks and fiscal authorities to provide additional support to households and businesses, particularly in the AFEs. High debt levels limited the fiscal space in some EMEs, and emergency aid to sustain employment and household spending expired in some EMEs with elevated fiscal concerns. Monetary policy across foreign economies was highly accommodative, and financing conditions remained supportive of growth, with a few major AFE central banks introducing new stimulus measures late last year. Indeed, market-implied policy paths for the Japanese, U.K., and European central banks signal a prolonged period of monetary accommodation (figure 40).

Even with substantial policy support, AFE unemployment rates at the end of 2020 are higher than they were before the pandemic. Unemployment rates in Europe and Japan rose moderately during the spring and have remained relatively unchanged (figure 41). Canada, however, endured a large and rapid increase in unemployment during the spring and a commensurate decline by year-end, similar to the U.S. experience. The country-specific dynamics of unemployment partly reflect differences in labor market structures, employment protection regulations, and the expansion of wage subsidy programs. In general, unemployment rates in the EMEs increased since the start of the pandemic, and some Asian economies adopted direct wage subsidies to avert large dislocations in their labor markets.

Despite the recovery in activity and employment in some sectors of the economy, lower overall demand and continued uncertainty about the path of the virus helped keep inflation subdued abroad. In many foreign economies, inflation remains below central banks' targets. In the euro area and Japan, the consumer price index fell in 2020, reflecting subdued inflation expectations and persistent economic slack (figure 42).

Longer-term sovereign yields remained low, while risk sentiment improved...

Longer-term sovereign yields in major AFEs have moved up, on net, but remained near historically low levels amid continued monetary policy accommodation (figure 43). Foreign equity markets rebounded in the second half of 2020, reflecting not only supportive monetary and fiscal policies, but also the development of effective vaccines. Although AFE stock markets largely recovered, they still underperformed U.S. equities, with greater restrictions on activity abroad and a lower share of companies that benefited from the digital economy (figure 44).

EME equity markets have recovered since the spring, with recent strong capital inflows (figure 45). Asian equity indexes rose well above pre-pandemic levels, while those in Latin America posted modest gains relative to a year ago, largely reflecting Asian economies' lower infection rates, better fundamentals, and larger fiscal space to provide additional stimulus (figure 46). Along with the improvement in equity markets, sovereign borrowing spreads generally narrowed, although they are still above pre-pandemic levels.

. . . and the broad dollar depreciated

The broad dollar index—a measure of the trade-weighted value of the dollar against foreign currencies—fell in the second half of last year. Both the continued improvement in market conditions following the stresses of last March and highly accommodative U.S. monetary policy contributed to dollar depreciation. On balance, the dollar has depreciated about 3.5 percent relative to a year ago (figure 47). The dollar broadly weakened against AFE currencies, notably the euro. The dollar also fell against some Asian emerging market currencies, particularly the Chinese renminbi and Korean won (figure 48).


 2. Since the beginning of the pandemic, a substantial number of people on temporary layoff, who should be counted as unemployed, have instead been recorded as "employed but on unpaid absence." The Bureau of Labor Statistics reports that, if these workers had been correctly classified, the unemployment rate would have been 5 percentage points higher in April. The misclassification problem has abated since then, and the unemployment rate in January was, at most, about 1/2 percentage point lower than it would have been in the absence of misclassification. Return to text

 3. Some other common wage measures are providing misleading signals at present because they are dominated by compositional effects: Pandemic-related job losses fell most heavily on lower-wage workers, which mechanically increased measures of average wages. For example, average hourly earnings from the payroll survey rose more than 5 percent over the 12 months ending in January. Similarly, the fourth-quarter reading on compensation per hour, which includes both wages and benefits, was 7.7 percent above its year-ago level. Output per hour, or productivity, has also been affected by the same composition effects, rising 2.5 percent over the four quarters of 2020, the fastest pace in a decade. Return to text

 4. The trimmed mean price index excludes whichever prices showed the largest increases or decreases in a given month. Over the past 20 years, changes in the trimmed mean index have averaged 1/4 percentage point above core PCE inflation and 0.1 percentage point above total PCE inflation. Return to text

 5. As these measures are based on consumer price index (CPI) inflation, one should probably subtract about 1/4 percentage point—the average differential between CPI and PCE inflation over the past two decades—to infer inflation compensation on a PCE basis. Return to text

 6. The Consolidated Appropriations Act, 2021, which was enacted in late December, should provide a substantial further boost to DPI in the first quarter of this year. Return to text

 7. The saving rate reached 26 percent in the second quarter of 2020—by far the highest level since World War II—before falling back as consumption rebounded and government transfers declined over the course of the year. Even so, the saving rate in the fourth quarter remained higher than in any other period since the 1970s. Return to text

 8. Food pantries saw a significant increase in demand in 2020, and there was a sharp increase in the number of families reporting that they did not have sufficient money to buy food. See, for example, Marianne Bitler, Hilary W. Hoynes, and Diane Whitmore Schanzenbach (2020), "The Social Safety Net in the Wake of COVID-19," NBER Working Paper Series 27796 (Cambridge, Mass.: National Bureau of Economic Research, September), to text

 9. In particular, during the pandemic, the real estate sector has made increased use of virtual tours, remote closings, and waivers on inspections and appraisals. Return to text

 10. These policy measures include the CARES Act from last spring and the Consolidated Appropriations Act, 2021, enacted in December. Passage of additional fiscal support remains under discussion. Return to text

 11. The Congressional Budget Office's projection and estimate can be found at Congressional Budget Office (2020), An Update to the Budget Outlook: 2020 to 2030 (Washington: CBO, September 2),; and Congressional Budget Office and Joint Committee on Taxation (2021), "H.R. 133, Summary Estimate for Divisions M Through FF Consolidated Appropriations Act, 2021 Public Law 116–260," cost estimate, January 14, to text

 12. State tax collection data are available through November 2020. For additional details, see Urban Institute (2020), "State Tax and Economic Review," State and Local Finance Initiative, November, (accessed January 2021).
Although depressed, tax receipts have not fallen as significantly as economic activity, for several reasons. First, some of the federal fiscal aid to households (for example, unemployment benefits) is taxable. Second, goods consumption, which is likelier to be subject to sales taxes than services, has largely held up. Finally, unemployment has been concentrated among low-income individuals, who pay less in income taxes. Return to text

 13. These measures are based on a straight read of market quotes and are not adjusted for term premiums. Return to text

 14. The results of the Survey of Primary Dealers and the Survey of Market Participants are available on the Federal Reserve Bank of New York's website at and, respectively. Return to text

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Last Update: August 11, 2022