Illinois’ state policy choices boost threat from potential U.S. recession

Illinois’ state policy choices boost threat from potential U.S. recession

Illinois is already behind the national pandemic recovery. As the risk of recession increases, Illinoisans could fall farther behind.

Illinois’ slow recovery from the COVID-19 pandemic may face a new threat: an economic contraction sparked by heightened global uncertainty, soaring commodity prices and tightening financial conditions.

In an abrupt shift from 2021’s strong growth, the U.S. economy shrank at an annual rate of 1.4% between January and March of this year – in large part because the U.S. economy is overheating.

The latest economic report shows U.S. demand is resilient in the face of many challenges – COVID-19, supply chains issues, labor shortages, a cooling global economy, a war in Europe and rising commodity prices. This is because personal consumption expenditures – roughly 70% of gross domestic product – and investment actually increased despite rapid price increases.

Higher input costs for producers harm U.S. economic prospects. Higher inflation can pull down U.S. output and exports because of higher prices faced by producers. Uncertainty in Europe and a weaker global economy have also strengthened the U.S. dollar and U.S. imports are soaring. As US exports become relatively more expensive, the strong dollar has a negative impact on earnings and economic growth. As a matter of simple accounting, lower net exports subtract from GDP.

The increase in the trade deficit is also a sign domestic demand is outstripping the economy’s productive capacity. That means the U.S. economy is overheating.

The personal consumption expenditures price index for March increased 6.6% from one year ago. Employment costs are also up 4.5% over the past year, according to data released by the U.S. Bureau of Labor Statistics.

An overheating U.S. economy will prompt the Fed to act more aggressively to combat inflation. Faster inflation will weigh down the U.S. economy. More aggressive action at the Fed to bring down inflation could also plunge the economy into a recession.

The latest economic data is likely to result in faster and more aggressive rate hikes.

Unfortunately, the Fed has rarely been successful at bringing down inflation without precipitating a recession. This time better be different, because a handful of states such as Illinois have not yet recovered from the pandemic downturn.

As of March 2022, Illinois was still missing 154,500 jobs that existed before the pandemic. At 4.8%, the state’s unemployment rate is the sixth highest nationally. If growth at the national level stalls or the U.S. economy contracts, Illinoisans will likely be worse off than other Americans.

To really tamp down inflation, either demand needs to decrease, or America needs a miracle increase in productivity. State policies could help.

While the Fed aims to bring down inflation, many states – flush with cash – are handing out money to their residents or introducing record spending plans. While these moves are politically expedient for politicians concerned with reelection, the increase in state transfers to households worsens the problem and provides only modest, temporary relief.

In Illinois for example, Gov. J.B. Pritzker is increasing state spending with his record $46.5 billion budget, which included salary raises for lawmakers and direct cash transfers to households. Rather than one-time handouts to households, structural reforms that increase the incentive to work and to innovate would expand potential output.

Lawmakers could start by addressing the $1.8 billion dollar unemployment trust fund deficit that will result in higher taxes for producers. Illinois could work to reduce the cost of doing business in Illinois, which is No. 3 in the U.S. for the most regulatory restrictions.  The state’s high business taxes also reduce innovation.

State lawmakers should work to make structural changes that can boost domestic production and keep the U.S. economy humming.

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