With economy poised for best growth since 1983, inflation lurks

Ronald Reagan was in the White House, "Return of the Jedi" was in theaters, and economic growth hit an astonishing 7.9%.

The U.S. has produced many more Star Wars films since 1983, but growth has never approached that level—until this year, if economists are right. Those surveyed by The Wall Street Journal boosted their average forecast for 2021 economic growth to 6.4%, measured as the change in inflation-adjusted gross domestic product in the fourth quarter from a year earlier. If realized, that would be one of the few times in 70 years that the economy has grown so fast.

"We had an incredible shock, but look how fast we’re bouncing back," said Allen Sinai, chief global economist and strategist at Decision Economics Inc. "We’re in the early stages of recovery, and we’ve got three to five years to go. I think we’re going to end up in a boom."

Economists expect growth to slow to 3.2% next year, which would still make 2021-22 the strongest two-year performance since 2005.

That boom might have a potentially troubling side effect. Inflation, as measured by the consumer-price index, is expected to jump sharply from 1.7% in February when March data is released Tuesday. That is partly a quirk of the data, as outright declines in consumer prices recorded at the start of the pandemic in March of last year drop from the 12-month calculation.

Still, economists see further price pressures as the economy reopens, with inflation accelerating to 3% in June, which would be the highest since 2012, before slowing to 2.6% by December. They see the Federal Reserve starting to raise rates in mid-2023, rather than 2024 or later, as officials at the central bank have indicated.

The Wall Street Journal survey of 69 business, academic and financial forecasters was conducted April 5-7. Not all participants responded to every question.

As recently as December, economists expected solid but unspectacular growth of 3.7% this year, reflecting the reversal of pandemic-induced shutdowns as well as the Fed’s low interest rates. Then, in the waning months of the Trump administration, the federal government authorized two Covid-19 vaccines, and Congress passed a $900 billion coronavirus relief package.

About a third of Americans have now received at least one shot, according to the Centers for Disease Control and Prevention, and Congress has approved another $1.9 trillion in fiscal support. On March 31, President Biden unveiled an infrastructure investment plan to be partly financed by higher corporate taxes.

"Both in terms of magnitude and timing, that was a bigger jolt to the economy than anticipated," said Michelle Meyer, head of U.S. economics at BofA Global Research, referring to fiscal stimulus. "Another very important factor is the vaccination campaign, which is happening faster than anticipated."

Economists in the survey on average now expect employers to add 7.1 million jobs in 2021, which would be the largest December-to-December gain on record and up sharply from 4.9 million projected in the survey late last year. At 5%, the increase would be the largest since 1978. The unemployment rate is expected to fall to 4.8% by year-end, compared with a projection of 5.6% late last year.

The outlook remains highly uncertain. In the past year, economists have alternated between excessive optimism and pessimism. Vaccine hesitancy, faster-spreading virus variants or the potential drag from a lagging overseas economy could yet undercut growth this year.

Growth of 6% or better was more common before the 1980s, when underlying growth was higher and usually came right after recessions with the help of loose monetary and fiscal policy. The contraction in output in the first half of last year was far more severe than any previous recession, so a strong recovery was partly inevitable. Indeed, GDP rebounded strongly in the third quarter of last year.

The scale of federal stimulus is greater than in the previous recoveries, at nearly $6 trillion, or more than one-quarter of annual GDP. Mr. Reagan’s combination of tax cuts and military spending was spread out over a longer period, said Mr. Sinai. "It makes it hard for a forecaster because I’ve not seen anything like this, ever," he said.

That stimulus has significantly boosted federal debt, which some warn could eventually raise interest rates sharply. Still, economists see the 10-year Treasury note yield rising only slowly from 1.66% on Friday to around 1.9% by the end of this year and 2.5% by the end of 2023, still lower than in 2018.

A hot economy could also bring the bugbear of inflation. Its path depends heavily on how easily surging demand can be met with increased production.

"How does it shake out? Well, no one knows because no one has seen such an experiment before—it’s like spending as much money to fight World War II except there’s no enemy, we’re not spending it on defense, and it’s not clear who will buy what," said James F. Smith, macroeconomist at EconForecaster LLC. "If the overwhelming majority of our demand goes to domestically produced goods and services, we’re going to see bottlenecks like we’ve never seen before." More likely, though, some of that U.S. demand will go toward goods and services from abroad, keeping prices in check, Mr. Smith said.

The Fed’s 2% inflation target is based on the price index of personal-consumption expenditures, which economists expect to advance from 1.6% in February to 2.5% by the fourth quarter, and remain above 2% through 2023. That is slightly higher than Fed officials themselves expect. The central bank has said it would start to raise rates when inflation reaches 2% and is headed higher and when full employment has been achieved.

This year’s unusually torrid projected growth might be powered not just by a return to pre-Covid-19 normalcy but also by technological, structural and policy changes that could boost growth potential beyond 2021, said Ms. Meyer.

"We went through so much pain as a society around Covid, and there were so many lives lost," she said. "But in a way the economy was put into hibernation for a period of time, supported by stimulus." In the intervening time, she added, firms invested in new technologies and rethought workforce management in ways that could boost productivity and labor-force participation. "The economy has now, in a sense, reset," she said.