The U.S. and Midwest Outlook for Themes for 2017 Outlook. What Won t Change From 2016

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1 The U.S. and Midwest Outlook for 2017 Rick Mattoon Senior Economist and Economic Advisor Federal Reserve Bank of Chicago Wisconsin Lenders Conference May 18, 2017 Themes for 2017 Outlook Absent unforeseen changes, the Congressional Budget Office has the US economy growing at 2% for as far as the eye can see. According to this scenario, trend growth has downshifted. Why is faster growth hard to come by? Demographics, we are getting older, prime work age population is declining as a share of population Productivity is in a rut. The last productivity spurt largely reflected the take up of IT in the economy. Incremental gains from IT have been smaller. Need a next big thing to push productivity back up? Boost from higher educational attainment has peaked. All of these are structural factors and can mute the impact of cyclical policies. Counter vailing force The return of fiscal policy? Still sluggish world economic outlook What Won t Change From 2016 Employment gains should hold and unemployment rate will stay low. Rest of the world economy won t grow particularly quickly. Consumer will still be the key. Right now they say they are very confident. U.S. Household wealth will continue to break records. Raising interest rates will still face some headwind from loose monetary policy in the rest of the world. 1

2 Thinking about the impact of fiscal policy Many forms tax cuts, infrastructure, defense spending Issues to consider Deficit impact Who benefits? Marginal propensity to consume Impact on monetary policy do interest rates rise? Impact on interest rate sensitive purchases like homes and cars Timing? Actions require legislative action, also timing relative to the condition of the economy (tight employment/rising interest rates?) Unintended consequences example state and muni debt, Lower marginal tax rates will lower the incentive for high income earners to buy muni debt Caps or outright elimination of tax free state and local debt issuance could raise state and local borrowing costs Employment Continues to Improve While Unemployment falls to 4.5% Still, the U 6, While Improving is Higher Than We Would Like, (8.9) 2

3 Households have deleveraged Key to Consumer Spending Atlanta Fed Wage Tracker Shows Wage Gains of 3.2% The Current Forecast Last FOMC (March, 2017) central tendency projection for GDP growth in 2017 is 2.0% to 2.2%. Long run 1.8% to 2.0%. Growth in 2018 at 1.8% to 2.3% Inflation is nearing the 2% target for PCE. FOMC forecast has PCE at 1.8% to 2.0% in Long run estimate is at 2%, with 2018 projected at 1.9% to 2.0%. FOMC forecast has unemployment 4.5% to 4.6% (2017), 4.3% to 4.6 % (2018). Long run 4.7% to 5.0% Fed policy. March, 2017 was the third quarter point increase since 2008 (.75 to 1% Fed Funds rate). Big issue will be the pace of potential future increases to get to normalization (now 2.9%). Latest meeting suggests possibility of 2 more hikes in

4 Midwest outlook Region has had an uneven recovery from the Great Recession. Initially best performance was in states with autos and ag but this has faded. Autos are flat to weakening and ag has had 3 straight years of poor crop prices and declining farm incomes. The most recent impulse for growth seems to be dominated by cities. 90% of all jobs added in Illinois are in metro Chicago. A similar story has plagued state and local governments. Revenue recovery has been weak with most states only getting back to their pre recession revenue peak in the last 2 years. Employment recovery (or lack of) tells the story. Job Recovery U.S. and Midwest Recovery Rate (% of jobs recovered since the end of the recession) Illinois Indiana Iowa Michigan Ohio Wisconsin U.S Wisconsin Job Recovery vs the US (February 2017) Wisconsin Losses during recession Performance during the recovery Recovery rate % Losses during recession U.S. Performance during the recovery Recovery rate % All industries ,393 14, Construction , Education, Health n/a 689 3,340 n/a FIRE 3 3 n/a Government 3 4 n/a n/a Information Leisure , Manufacturing , Other services 0 14 n/a Prof. and Business Svs. Trade, Transport and Utilities ,615 4, ,806 2,

5 An example of a sector with a subpar recovery state and local government Underperforming revenue recovery is stressing all levels of government. States and locals may be more on your own than in the past. Federal support will likely decline. (ex. Block grant Mediciad) Broad national trend of reduced state aid to local governments. Worse yet, shifting costs to local governments pensions, OPEB What is the strategy? Stress test your revenues for volatility build an appropriate rainy day fund. A new normal for government revenues and changing assumptions about investment returns one example. pensions? Changing risk profile to get a 7.5% return Pensions are the most visible problem, but even this may be understated actuarial reported versus market Illinois 2014 All State and Local All State Systems Local Systems Systems Pension debt $140,261,234 $99,978,217 $40,283,017 (thousands) Funded ratio 44.5% 44.5% 44.5% Assumed rate of 7.89% 7.89% 7.89% return Debt per household $29,390 $20,949 $8,441 Debt as a share of 3.81% 2.72% 1.10% total (S +L) general fund revenues 5

6 But if you change a few assumptions, things look much worse Illinois 2014 Market Pension debt market (thousands) All State and Local Systems All State Systems Local Systems $371,398,779 $264,733,075 $106,665,704 Funded ratio 23.3% 23.3% 23.3% Assumed rate of 3.0% 3.0% 3.0% return Debt per $77,822 $55,471 $22,350 household Debt as a share of total (S +L) general fund revenues 10.10% 9.33% 3.76% Conclusions Underlying structural growth in the US economy has declined due to demographics and poor productivity growth. Midwest recovery has been uneven but generally has underperformed the US average. 6