October 11, 2024

In an 1850 essay entitled “That Which is Seen and that Which is not Seen,” French economist Frédéric Bastiat laid out what he called the broken window fallacy. In it, a child breaks a window of his father’s shop. A neighbor commiserates with the father but tells him the accident is really a blessing in disguise.

He argues that the money the father must now spend to repair the window creates jobs. It will create a job for the glassmaker, who will then spend the proceeds of their work elsewhere in the community. The result multiplies and ripples throughout the community.

That is important for economic growth, which counts activity, but is only a part of the story. It focuses only on what is seen.

What is unseen is that the father could have spent the funds needed to fix his window on something else. Maybe he needed a new pair of shoes. That would still create jobs but leave him better off than spending funds for repairs. He would have both a functioning window and new shoes.

That provides a useful context for understanding the economic fallout from natural disasters. They trigger spending via a drawdown of savings, often rapidly, but ultimately leave us with less wealth. Those opportunity costs leave us worse off over time. That is on top of the grief and devastation created by disasters.

Wealthy countries tend to rebuild more rapidly after disasters than those with less wealth. However, the US has been much slower to rebuild than it did in the past, in part due to the surge in the frequency and ferocity of natural disasters in recent years. (See Chart 1.)

The cost of climate change is already being felt in escalating insurance costs. Flood and fire insurance are particularly prohibitive.

Those most exposed to climate-related risks tend to be lower income households. Foreclosures surged in the wake of Hurricane Harvey in Houston, as many of those hit hardest lacked the means to rebuild.

It is still too early to assess the damages. Hurricane Milton was barreling toward the coast of Florida as I was penning this report. Many of the same communities were still reeling from Hurricane Helene, which hit less than two weeks prior. Hurricane season is not over.

The Federal Emergency Management Agency (FEMA) has funds for immediate disaster relief. However, Congress punted on the fiscal year 2025 budget and opted to keep the government open with a continuing resolution. Congress did not approve supplemental disaster relief funds; those will be needed for longer-term recovery and rebuilding efforts.

This edition of Economic Compass provides a closer look at our baseline forecast prior to the hurricanes. Special attention will be paid to how the damages and efforts to rebuild could impact that outlook by sector. There is both an upfront blow to activity, and a bump in spending as wealth is depleted to make repairs. Supply chains could also be affected.

Congress punted on a budget yet again and opted to keep the government open via a continuing resolution in the fourth quarter. That suppresses federal spending.

The wildcard is disaster relief. Congress is in recess until November. Leaders in the House and Senate have said they could revisit the issue after the election.

State and local governments, which make up the lion’s share of government spending, should slow. Revenues fell short of expectations across states in fiscal 2024, which are expected to be a drag on spending. 

Repairs to infrastructure triggered by the hurricanes could offset that weakness. “Rainy day funds” ballooned in the wake of the pandemic; this is what they are for.

The trade deficit widens

Earlier dollar appreciation and excess capacity abroad suggest that imports will swamp exports in the fourth quarter. Retailers continue to order for the holiday season, despite some stockpiling due to concerns over port strikes. The trade deficit will widen and act as a drag on overall growth.

Prospects for early 2025 are not much stronger, as rate cuts will take time to boost growth across many of our trading partners. Equity markets have rallied on the heels of stimulus in China. It is unclear how far that stimulus will go in fueling demand given the ongoing overhang of debt in the real estate market and across regional governments.

The largest threat to trade is a full-blown trade war. History is not kind to countries which engaged in such policies. Across-the-board-tariffs spur inflation, curb competition and invite retaliation. Vicious cycles of escalating costs and weaker growth tend to ensue.

Risks to the outlook

Disruptions due to the hurricanes could dampen growth in the fourth quarter of 2024 and boost growth in 2025. Much depends on how many communities can be rebuilt. Many will be displaced to neighboring cities and states. Some people never returned to New Orleans in the wake of Hurricane Katrina.

Those relocations will increase the demand for housing. The shortfall in affordable housing will worsen. More resources will be needed to make communities more resilient and mitigate the damages due to extreme weather events.

Subdued inflation

Overall inflation cooled, while core inflation, excluding food and energy, held close to the pace of August in September. The buoyancy of core inflation is largely due to a sharp improvement in inflation a year ago. Those “base effects,” as they are known, fall out of the data at the start of 2025. After that, year-on-year measures of inflation move toward the Fed’s 2% target.

The dispersion of outsized price increases has abated. The appreciation in the dollar we saw earlier in the year and excess capacity abroad should put downward pressure on prices.

Shelter costs finally cooled. That will provide some offset for the rise in costs due to the hurricanes. Disruptions due to supply chains are expected but firms have proven themselves nimbler than during the pandemic. That has muted the pass-through to consumers.

Productivity growth has picked up. That reflects investments made early in the recovery as firms pivoted online and we all learned to better leverage existing technologies. Tight labor markets and hybrid work arrangements better matched workers to their skills, which added to productivity. Those increases are enabling firms to absorb higher input costs without passing them onto consumers.

The last time we experienced that kind of a boost to productivity was in the late 1990s. Those shifts paid a dividend in higher productivity well after they faded in the early 2000s. We will need it, as disruptions due to weather are only one aspect of a host of disruptions that lie ahead.

Upside risks. Inflation could cool less rapidly than forecast due to the ripple effects of recent disasters and escalating tensions in the Middle East. This is in addition to the threat that extreme weather events become more frequent and destructive, which will further stress existing resources and bid up insurance costs.

Separately, aggressive tariffs and curbs to immigration tend to stoke inflation and stem growth. Those pressures would add to the upside push on inflation associated with widening government deficits and debt. Both policies are more inflationary post-pandemic than they were pre-pandemic.