Omicron adds new chapter to Covidonomics textbook

BofA Global Research with the note:

The impact of Covid on the economy has evolved over time. Here we argue Omicron adds a new chapter to the Covidonomics textbook:

  • Successive waves of Covid are increasingly impacting the supply-side of the economy more than the demand-side.
  • The biggest impact from Omicron will likely be a large temporary loss of workers due to quarantines.
  • The upshot is to extend the period of tight capacity and inflation pressure and add another nudge to Fed rate hikes.

Prior to the Covid crisis most of the literature on pandemics focused on their impact on labor supply due to illness and deaths. However, in the first wave of Covid, the main shock to the economy came from lockdowns and other restrictions on activity. Over time the impact of Covid waves has gotten smaller and increasingly is driven by voluntary changes in behavior.

The delta wave brought a new dimension to the shock: the impact on the supply side of the economy was greater than the demand side. Rising cases had a relatively modest impact on aggregate demand. People have learned to keep spending through the Covid wave, supported by record net worth and savings. At the same time, the supply-side constraints have gotten more binding:

  • Covid waves have helped maintain very high spending on goods rather than inperson services, testing the limits of goods production and distribution. This is particularly the case in the US due to the massive fiscal stimulus in the past year.
  • After a significant recovery in the job market, people least worried about catching Covid are now employed, while the remaining workers on the sidelines tend to be the most fearful of getting Covid. Each Covid wave is another reminder to them of the risks of a return to work. Again, the US stands out.

With the Omicron variant, the economic linkages continue to evolve. Omicron has triggered lower hospitalization rates so far, particularly for vaccinated people. Moreover, the general public has become less willing to trade off economic engagement for reduced health risk.

The new challenge with Omicron is the dramatically higher case load. There have been an average of 405,000 new Covid cases in the US in the last seven days and they continue to surge. Moreover, with the rapid deployment of at home test kits, the actual number of positive results is likely much higher. According to a New York Times piece: “There is no comprehensive data on how many rapid tests are used every day, but experts say it is most likely far higher than the number of [PCR tests]… which are reported publicly as aggregate totals.” Hence, as a conservative estimate, suppose 2 million people per day test positive for Covid in the coming weeks.

Show your math

A quick back of the envelope calculation illustrates the kind of labor shortages this could trigger. Suppose that every infected person on average causes themselves and two other people to quarantine for five days. That means at the peak of omicron wave 30mn (= 2mn * 3 * 5) could be quarantined per day. Of course, many of these people either don’t work or can work from home. Roughly half of the population work and among them, according to a Gallup poll, about 30% always work in person. This suggests that 4.2 million (= 30 mil * 0.5 * 0.3) in-person workers per day will be absent due to quarantining. This number could be too high or too low, but a multi-million number seems very likely.

These calculations underscore that the well-advertised worker shortages in the airline industry are not an isolated problem. Generally speaking these absences will not show up in official estimates of labor supply—if you are home sick, you are still employed. Nonetheless, they add (temporarily) to the record 11 million job openings. This extends the period of wage and price pressure, adding an extra nudge to the Fed to start hiking rates.

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