The Outlook for the U.S. Economy: Sunny Skies But Developing Storm Clouds? 2018 Investment in Infrastructure Expo St. Charles, MO Kevin L. Kliesen Business Economist and Research Officer February 27, 2018 1
Disclaimer The views I will express today are my own and do not necessarily reflect the positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. 2
The Big Picture We re into the 8 th year of expansion... The average expansion lasts about 5 years. Real GDP growth during this expansion has averaged about 2.25% per year. Historically, growth has averaged about 3% per year. There are many reasons for weaker growth: Deleveraging, tighter access to credit, reregulation, higher taxes, demographics, and less innovation. Inflation has been below the FOMC s 2% target for most of the past five years. 3
Forecasting Basics Joke of the Day! Economic forecasting is an imprecise exercise. Forecasters have a lot of hurdles to overcome: Imperfect data and models, assumptions about economic policy, unexpected developments (shocks) can t be accounted for. So, we assume to a large degree that the past is prologue, but recognize that households, firms, and governments can change their behavior. Incentives matter! Bottom line: Look at long-run trends and then attempt to assess where the economy is currently relative to trend. 4
So Many Questions! Is 2.25% economic growth still the norm? Or, will tax reform boost the economy s short- and longterm prospects? How should we think about the increase in the budget deficit due from tax cuts and increased spending? Is inflation temporarily low? Are we stuck in a low interest rate regime? If so, what does that imply for the economy and monetary policy? 5
The Future Ain t What it Used to Be? Per Capita Real GDP, 1984 to Present Billions of $2009 65,000 60,000 The Labor Force Participation Rate and the Employment-to-Population Ratio, 1984 to Present Percent 68.0 55,000 50,000 66.0 64.0 Participation Rate 45,000 40,000 35,000 30,000 25,000 1984 1988 1992 1996 2000 2004 2008 2012 2016 SOURCE: U.S. Bureau of Economic Analysis Data through 2017:Q4 62.0 Employ/Pop 60.0 58.0 56.0 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 Source: Bureau of Labor Statistics. Data through January 2018. 6
The Future Ain t What it Used to Be? Growth of Labor Productivity, 1948 to 2017 Percent change, annual data 8 7 6 5 4 3 2 1 0-1 -2 1948-73 (2.8%) 1974-95 (1.5%) 1996-2005 (2.6%) 2006-2017 (1.2%) -3 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 NOTE: Labor productivity is output per hour in the nonfarm business sector. Data for 2017 are for the first three quarters of 2017. 7
The Future Ain t What it Used to Be? The Fed's Preferred Inflation Measure Percent change from a year earlier 4.0 Long-Term Inflation Expectations (Inflation expectations based on TIPS 4.0 3.0 3.0 Inflation Expectations 2.0 FOMC Inflation Target (2%) 1.7 2.0 1.97 1.0 1.0 FOMC Inflation Target (2%) 0.0 Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 NOTE: Inflation calculated from the personal consumption expenditures price index. Last observation is September 2017. Source is the Bureau of Economic Analysis. 0.0 Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 NOTE: Inflation calculated from the personal consumption expenditures price index. Inflation expectations are 5-year, 5-year forward break-even inflation rates. 8
A New Normal for Inflation? Some economists are beginning to wonder if 2% inflation is attainable in light of fundamental changes in the economy. For example, the fracking revolution in the United States seems to have permanently lowered the price of crude oil ( shale band ). Others wonder whether the Amazon effect has exerted similar effects on retail prices. 9
Current Economic Developments 10
Current Economic Conditions Solid labor market conditions and low inflation. Consumer optimism supports spending on autos and other big-ticket items. Global growth looks pretty strong even Europe is experiencing strong growth! Financial market volatility! Melt-up... Melt-down... Healthy forward momentum in the second half of 2017 bodes well for 2018 and 2019. Businesses are optimistic. 11
Two Key Barometers Look Good ISM Diffusion Indexes Index, 50+ = Expansion 65 60 55 50 45 40 35 Services Manufacturing ISM Manufacturing New Orders Index Index, 50+ = Expansion 70 65 60 55 50 45 Orders Index 30 Jan.2005 Jul.2007 Jan.2010 Jul.2012 Jan.2015 Jul.2017 Last actual observations: January 2018 40 Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 Last actual observation is January 2018 12
Current Economic Conditions WHAT PURCHASING MANAGERS ARE SAYING Sales nationally and internationally are strong in Q1. We are increasing our CapEx spend by 30% to 40% over [the] previous year. (Chemical Products) We have heard reports of additional business due to the recent reduction of tax rates. (Machinery) Business outlook is positive on all fronts right now with our customers. (Computer & Electronic Products) Our usual winter slowdown has not occurred, and we are very busy with new orders. (Furniture & Related Products) Executive management [is] excited about tax breaks for CapEx purchases in the new tax bill. (Information) 13
Forecasters: Expect More CapEx What Are Forecasters Predicting for Real Business Capital Expenditures (Fixed Investment)? Percent changes at annual rates 10 8 6 4 2 0-2 -4-6 Actuals -8 2015:Q1 2015:Q4 2016:Q3 2017:Q2 2018:Q1 2018:Q4 SOURCE: Survey of Professional Forecasters, Aug. 2017 and Feb. 2018. Feb. 2018 Forecasts Aug. 2017 Forecasts 14
Construction Outlook Appears to be Improving Dodge Momentum Indexes: Commercial and Institutional Building 2000 = 100 225 Commercial Building Planning Index 200 Institutional Building Planning Index 175 150 125 100 75 50 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 SOURCE: Dodge Data & Analytics Data through Jan. 2018 National Home Builders Housing Market Index Index, All Good = 100 80 70 60 50 40 30 20 10 Average, 1985-2005 0 Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 Source: NAHB Last actual observation is Feb. 2018. 15
Near-Normal Growth in State & Local Government Spending What Are Forecasters Predicting for State & Local Real Expenditures? Percent 6.0 4.0 2.0 0.0-2.0 Contributions to Real GDP Growth from Real State & Local Expenditures Percentage points 0.20 0.10 0.00-0.10 0.13 0.10-4.0-6.0-8.0 S&L Growth 2017:Q4 SPF (Feb. 2018) -0.20-0.30-0.40-0.34 2005:Q1 to 2009:Q3 2009:Q4 to 2012:Q4 2013:Q1 to 2017:Q4 SOURCE: Survey of Professional Forecasters SOURCE: Bureau of Economic Analysis 16
Growth in Public Capital Spending Lags in Some Areas Real Public Capital Stock Per Worker, Selected Categories Chain-weighted, 2009 dollars Growth Rates Per Worker Amounts ($) 1997 to 2007 to 1997 2007 2016 2007 2016 Total $36,581 $39,599 $42,193 0.80 0.71 Structures 29,139 31,601 33,414 0.81 0.62 Health Care 1,025 1,002 1,101-0.23 1.06 Education 4,292 5,419 6,041 2.36 1.21 Public Safety 943 974 951 0.33-0.26 Transportation 1,242 1,591 1,794 2.51 1.35 Power 914 939 1,048 0.27 1.22 Highways 8,701 9,169 9,390 0.53 0.26 Military 2,704 2,273 2,124-1.72-0.75 Addenda Growth rate of real GDP per worker 1.84 0.94 NOTE: Total government capital stock. SOURCE: BEA and Author's calculations 17
Unemployment Rates are Low, Regardless of How Measured The U-3 (Official) and U-6 Unemployment Rates and ther Long-Run Median Unemployment Rates Percent 18.0 15.0 12.0 (Dotted Lines are Long-Run Medians) U-6 9.0 6.0 U-3 3.0 1992 1995 1998 2001 2004 2007 2010 2013 2016 4.1 9.7 8.2 5.6 Source: Bureau of Labor Statistics. Data through January 2018. 18
Where are Job Openings the Most and Least Plentiful by Industry? Change in Job Openings Over the Past Year Percent change, Dec. 2016 to Dec. 2017 Leisure & Hospitality 21.9% Construction 12.9% Government 9.9% Trade, Transportation & Utilities 6.9% Manufacturing 6.4% Education & Health Care Services -1.9% Professional Business Services -3.3% SOURCE: Bureau of Labor Statistics 19
Wage Growth is Picking Up According to Small Businesses Percent of Small Businesses Raising Labor Compensation Over the Past Three Months 40 35 30 25 20 15 10 5 0 2004 2006 2008 2010 2013 2015 2017 Last actual observation is January 2018 20
Wage Growth is Picking Up but Inflation Remains Below 2%. The Atlanta Fed Wage Growth Tracker and Headline Inflation Percent change from a year earlier 5.0 4.0 3.0 2.0 1.0 0.0-1.0 Wages Inflation -2.0 Jan.2005 Jan.2007 Jan.2009 Jan.2011 Jan.2013 Jan.2015 Jan.2017 A widening gap is good because it signals improving purchasing power of households (inflation-adjusted wages). Last actual observation is Dec. 2017/Jan. 2018. 21
Are Households Too Optimistic? Consumer Confidence Index 130 120 110 100 90 80 70 60 50 40 30 Jan.2000 Jan.2003 Jan.2006 Jan.2009 Jan.2012 Jan.2015 Jan.2018 NOTE: Avg. of Michigan and Conference Board surveys. Last monthly observation is Jan. 2018. Personal Saving Rate Percent of disposable personal income 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2005 2006 2008 2009 2011 2012 2014 2015 2017 2018 SOURCE: BEA Last actual observation is December 2017 22
The FOMC: We re Bullish on the U.S. Economy! The Actual and Projected Federal Funds Target Rate Percent 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2005 2007 2009 2011 2013 2015 2017 2019 Fed Funds Rate FOMC SEP, Dec. 2017 Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low. [FOMC Statement, Jan. 31, 2018] 23
Why You Should be Optimistic Cuts in marginal tax rates, coupled with increases in household wealth, should keep consumer spending and housing construction growing at healthy rates. Tax law changes will encourage firms to boost capital spending, hiring, and repatriate foreign profits. All else equal, these developments will tend to raise productivity, real wages, and economic growth. Unless inflation ramps up, the FOMC will be patient in withdrawing monetary stimulus. 24
Kliesen s Forecast Last Year (2017) Projected averages, 2017 to 2019: Real GDP growth: 2.25% to 2.75% Unemployment rate: 4% to 4.5% Headline inflation: 2% (some upside risk) Punchline: Policy changes, if realized and designed appropriately, could boost economic growth by 0.5% to 0.75%. But inflation will need to stay low. 25
Kliesen s Forecast, Circa 2018 Projected averages, 2018 to 2020: Real GDP growth: 2.5% to 3.0% Unemployment rate: 3.75% to 4.25% Headline inflation: 2% (some upside risk) Punchline: Policy changes will boost economic growth. Inflation fears have crept into the market, so the Fed will need to remain vigilant. 26
QUESTIONS? 27