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Another Good Sign on the Economic Recovery — and a Warning

What “normal” looks like right now. Photo: Stephanie Keith/Getty Images

Americans saved 23 percent of their after-tax income in May, which would have been by far a record if not for the fact that they’d already set a record of 33 percent in April. The high saving rate, shown in data from the Bureau of Economic Analysis, is because consumer spending remains below precrisis levels, while income (and after-tax income) have gone up, due to extensive federal government financial support to businesses and households — especially the increase and expansion of unemployment benefits.

Personal income was not as high in May as in April, because stimulus payments to most American adults had mostly been distributed in the latter month. But incomes were still 8 percent higher than last May, reflecting the surprising fact that the average American has more income during the pandemic than previously.

And consumer spending, while still 10 percent below last May’s level, rebounded strongly from April, driven especially by increases in spending on motor vehicles, “recreational goods and vehicles” (a category that includes televisions and computers), food services and accommodations, and health care. The rise in spending on the service categories is a sign that consumers are increasingly willing to patronize businesses that have been permitted to resume more normal operations. (This applies even to health care, where non-COVID-related care was widely postponed or forgone in the depths of the lockdown.) The rise in spending on durable goods is a sign that consumers are both able to go out and make major purchases and feel financially strong enough to do so.

The pending expiration of CARES Act benefits at the end of July remains a significant risk to the economy. And even if Congress reaches a last-minute deal to extend significantly enhanced unemployment benefits for several more months (an outcome I think is likely), there may be a scramble and a delay in some payments as state unemployment agencies rush to implement whatever new benefit rules Congress sets. This is a reason Congress should have acted sooner. But the unprecedentedly high levels of household saving this spring should go a significant way to help most households deal with a delay in those payments. However, the possibility that state and local governments will be left with insufficient aid to avoid extensive layoffs and program cuts is another risk to the economy.

Another concern about the economy comes from an announcement the Federal Reserve made this week that it will require large banks to suspend share repurchases to ensure they remain sufficiently well-capitalized to ride out the pandemic. The Fed will also limit those banks’ dividend payments, using a formula based on their recent income.

This ensures that large banks hold onto more of their capital than they otherwise would have, increasing their ability to absorb losses from bad loans if economic outcomes from the coronavirus are worse than expected. Because it promotes bank solvency, the Fed’s move should be positive for both the financial system and the economy. And the mandate to limit shareholder payouts also helps fix a coordination problem: A bank’s executives might think it is a good idea to stop repurchases or reduce a dividend, but if they do so on their own, investors might take that as a sign that the bank is in particular financial distress. On the other hand, the fact that the Fed thought this action was necessary is a sign that policy-makers there believe there could be significant risk on the horizon, even as many indicators point in a positive direction right now. (One member of the Federal Reserve Board, Obama appointee Lael Brainard, would have gone even farther, requiring these banks to temporarily stop dividends altogether.)

The risk for the banks comes from the fact that a lot of financial investments are currently in a state of suspended animation. Retail and office landlords often have empty or near-empty buildings, where tenants have stopped paying rent due to the disruption of their own businesses. If those tenants never come back, the value of the buildings will be impaired in a way that could cause losses to the banks that have made loans against them. Similarly, people who have lost jobs are now relying on unemployment benefits and mortgage forbearance programs, but a persistent period of high unemployment is likely to eventually lead to a significant increase in home foreclosures. During a period of extended economic distress, individuals and businesses may also default on loans unrelated to real estate. All those factors mean banks could lose money and may need the capital the Fed is telling them to hold onto.

Finally, there’s a significant possibility that the worsening coronavirus trajectory in some parts of the country will temper the positive trends in consumer spending while exacerbating the damage to bank balance sheets. If Americans in much of the country, who decided it was safe to go to restaurants again in May, conclude in July that they should not do so, there could be a dip again in consumer spending. This is a reason one of the models the Federal Reserve used to decide it needed to restrict banks’ share buybacks was a so-called “W” double-dip recession, in which economic activity falls and rises, and then falls and rises again. This is not the base case — in part because we’ve gotten better at more targeted interventions, coronavirus-fighting measures that get imposed now are likely to be less economically disruptive than those that prevailed in March. But it is a significant risk nonetheless.

Another Good Sign on the Economic Recovery — and a Warning