Limited economic upside?
September 19 – September 23, 2016
This being a presidential election year, views on the economy vary widely. The labor market has improved substantially in the last few years, to the point where we are seeing some evidence of wage pressures. On the other hand, growth in inflation-adjusted Gross Domestic Product has been low by historical standards. Many Americans have not participated in the economic recovery, but most are better off than they were a year or two ago. At any particular time, some sectors of the economy will do better than others, and with a slower trend growth in GDP, some are likely to appear weak. This can create uncertainty about where the overall economy is headed.
Real GDP rose 1.2% over the four quarters ending 2Q16. However, growth was restrained by slower (and more recently, declining) inventories. Final Sales (GDP less than change in inventories) rose 1.9%. And if you also exclude net exports and government (Private Domestic Final Purchases, a better measure of underlying demand), growth was 2.3%. Inventory growth is expected to pick up in the second half of the year, providing a short-term boost to overall GDP growth, but we saw little improvement in the data for July.
In late summer, the Census Bureau releases its annual report on income and poverty. The latest figures showed that real median household income rose 5.2% between 2014 and 2015, the first annual increase since 2007 and the largest gain since 1967, when data were first compiled. Gains were widespread across categories (household type, race, age), with the lone exception of those outside metropolitan statistical areas (-2.0% y/y). Real median household income was still below where it was in 2007, before the recession began (also about where it was in 1998). However, it is moving in the right direction.
With a goal of being better able to manage the economy, the government began collecting economic data following the Great Depression. Naturally, these reports focused largely on the manufacturing sector. After WWII, manufacturing accounts form nearly one of three jobs in America. That percentage has drifted lower over time. Currently, manufacturing accounts for 8.5% of nonfarm payrolls (or about one in 12 jobs).
Industrial production has fallen 2.1% since November 2014, but that decline largely reflects the sharp drop in oil and gas well drilling (which fell 76% from December 2014 to May of this year). Energy exploration (which is capital intensive) has stopped falling, which means that the sector should no longer be a drag on business fixed investment and overall GDP growth. Factory output has been mixed, but generally soft, over the last several months, reflecting weak global growth and lower capital spending in the U.S. and abroad. Global growth ought to pick up, but the shifting demographics implies that labor input will grow more slowly than in recent decades.
Foreign trade has played a part. In the 1980s, the U.S. lost about one of ten manufacturing jobs each year – but each job lost was replaced by a new job. For many years, low-end productivity jobs moved overseas and higher-productivity jobs were created to take their place. As Chinese exporting capacity ramped up in the 2000s, many U.S. manufacturing jobs disappeared and were not replaced.
However, there are benefits, as well as costs, to foreign trade. Tearing up trade agreements is likely to be counterproductive. Limiting cheap imports would boost inflation, reducing real incomes and dampening consumer spending growth. Retaliation would restrain U.S. exports, an increasingly important area of the economy.
Short-term bursts of GDP growth are possible. However, unless productivity growth picks up sharply or we substantially increase immigration, slower labor force growth will limit potential GDP growth over the foreseeable future.
The return of fiscal policy?
September 12 – September 16, 2016
The world’s central bankers are tired of having to do all the heavy lifting to support growth. Some have suggested the need for fiscal policy to take a bigger role. Is that a good idea? Is expansionary fiscal policy even feasible at this point?
Fiscal policy refers to using tax cuts or spending increases to spur economic growth. The idea is that if the government builds a road or a bridge, the wages earned will be spent, and that spending is someone else’s income, part of which also gets spent. If well below full employment (as in a recession), the impact of additional government spending will be multiplied. The tricky part is in deciding when that added spending will be pulled back (hopefully, after the economy has fully recovered). Government debt will be higher, but may be paid down gradually once the economy recovers. Tax cuts can also stimulate the economy, but only if seen as permanent (temporary tax cuts in a recession are ineffective, but politicians always seem to include them in stimulus packages).
The American Recovery and Reinvestment Act of 2009 (ARRA), provided support for the economy at a cost of $831 billion, mostly spread between 2009 and 2011. A little over a third of that was in temporary tax cuts (ineffective). ARRA provided $543 billion in additional spending. That sounds like a lot, but it wasn’t compared to the decline in overall economic output (nominal private domestic purchases had fallen by $754 billion from 4Q07 to 2Q09). The federal deficit ballooned to $1.4 trillion (or 10% of GDP) in FY09, but that simply reflected the magnitude of the economic downturn. Revenues dried up. Spending on things like food stamps and unemployment benefits rose sharply. As the economy recovered, revenues improved and the recession-related spending went away. With less than a month remaining in FY16, the deficit is on track for about 2.9% of GDP, up from 2.5% of GDP in FY15.
While there was much hand-wringing over the deficit in 2009 and 2010, the problem has always been in the future. While the deficit has declined as a percentage of GDP, pressures will build as the baby-boom generation continues into retirement. Social Security is not in a terrible situation, but Medicare spending is set to explode, reflecting the ageing of the population and the long-standing trend of high inflation in healthcare. Paying for the healthcare and retirement of the elderly is not an issue unique to the U.S. Every other country faces a similar problem.
While the ARRA did help to limit the economic downturn, it wasn’t large enough to propel the economy to a strong recovery. This recovery also differed from past recoveries in that state and local government did not provide a base level of support. In fact, they made the recovery worse. Most states and cities have balanced budget requirements. So, when the recession hit and revenues dried up, most cut spending (laying off teachers, police, and firemen). Employment in state and local government is still well below the pre-recession level.
No serious economist advocates using fiscal policy to fine-tune the economy and many are divided on whether fiscal policy works well in fighting a recession, but that’s precisely when you’re going to get more bang for your buck. In an economy that is closer to full employment, fiscal policy is going to be less stimultive and may crowd out private activity. Moreover, with budget pressures looming, there’s little political scope for expansionary fiscal policy (but at least we should see the end of counter-productive austerity measures).
And yet, there is a definite need for more infrastructure spending in the U.S. Both presidential candidates have proposed spending more to repair roads and bridges. Even if you don’t believe in global warming, improvements in sewer, drainage, and other systems are clearly needed (as evidenced by the aftermath of Hurricanes Sandy and, more recently, Hermine). The question is who is going to pay for that.
The August employment report
September 5 – September 9, 2016
Nonfarm payrolls rose less than expected in August. Monthly changes have been uneven in recent months, which is consistent with the usual noise in the data, although the underlying trend appears to have slowed this year. Job growth should slow as the job market tightens, but how much slack remains in the job market? That’s an important question for Fed policymakers as they consider what to do in September.
Private-sector payrolls averaged a 150,000 gain over the last six months, down from 221,000 in 2015 and 240,000 in 2014. Some of that slowing likely reflects greater business caution, particularly in the goods-producing industries, manufacturing and construction. Payrolls in service-producing industries have slowed somewhat, but remain relatively strong. Some slowing in job growth was expected this year as the job market tightens and firms find it more difficult to find qualified workers. Government jobs picked up in the last three months, mostly at the local level, and mostly in education (suggesting that there may be some issues with the seasonal adjustment).
The unemployment rate held steady at 4.9% in August, down only modestly from a year ago. Normally, one would expect the unemployment rate to fall more slowly as the job market strengthens, as those on the sidelines (out of work but not officially classified as “unemployment”) are lured back into the workforce. However, labor force participation was also unchanged last month and up only slightly from a year ago. Clearly, recent retirees and stay-at-home spouse aren’t being lured back into the job market.
A tighter job market would normally lead to increased wages, and there are some signs of this in certain sectors (such as information technology), but wage growth has not picked up much. Luckily for consumers, inflation has remained low, leading to relatively strong gains in real hourly earnings.
Last week, the government reported revised productivity figures for the second quarter. Labor productivity was revised lower, in line with expectations given the GDP data, but unit labor costs were revised sharply higher. Granted, quarterly figures tend to be erratic, but the underlying trend of slow productivity growth is disturbing. Unit labor costs, the key measure of inflation from labor, are trending at a faster pace. This should results in higher inflation (if firms can pass the higher labor costs along) or will eat into profit margins (if they can’t). At the very least, we can expect to see some adjustments in the overall economy, as some sectors will have to adapt over time.
For the Federal Reserve, the August employment data provide no easy answers – not strong enough to force the Fed to tighten, not weak enough to take a possible September move off the table. Slow productivity growth implies that the Fed should raise rates sooner than they would otherwise, but not by as much in total. Hence, the short-term hawkishness and long-term dovishness expressed in the last couple of weeks.
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