- The economy is growing, and will grow at the fastest pace in 2014 since before the Great Recession.
- Still, the growth will be modest because of the restructuring that needs to occur in the economy.
- The Federal Reserve can do little to improve this situation, and needs to use this time to return to non-emergency policies and procedures.
I'm still comfortable with my forecast of a 3.0 percent rise in real Gross Domestic Product for this year. This is not a real robust rate of increase, but put into the context of the past several years, it is an encouraging performance.
Year-over-year, the rate of increase in 2013 was 2.6 percent, up from 2.0 percent in both 2012 and 2011.
Industrial production was growing at a 3.4 percent rate year-over-year in the first quarter, up from 3.3 percent in the fourth quarter of last year and from 2.7 percent in the third quarter.
In March, industrial product data were up by 3.8 percent from a year ago, and this was after an increase of 2.9 percent in January and 3.5 percent in February.
The March figure on new orders for manufactured durable goods, just released, shows a 2.6 percent monthly rise, and this was up from a 2.1 percent rise in February.
The sales of new homes in March declined, but this series is very volatile in the winter months, and shouldn't be emphasized too much.
Capacity utilization in manufacturing rose above 79.0 percent in March, the highest figure achieved in this period of recovery. This figure has risen steadily throughout 2013 into early 2014.
Labor force participation remains around 63.0 percent.
These figures point to a rate of growth in the economy around 3.0 percent, but are not so robust as to suggest that the 2014 figure will be anything much in excess of the number.
On the inflation front, the price index related to personal consumption expenditures, the index preferred by officials at the Federal Reserve, continues to show increases right around 1.0 percent. In the fourth quarter of 2013, the rate of increase in this index was also 1.0 percent. In the third quarter, it was 1.1 percent, and in the second quarter, it was 1.2 percent.
So, economic growth seems to be picking up modestly, while inflation continues to be stay subdued.
Inflationary expectations, as estimated from the government bond market, remain in the 2.0 percent to 2.2 percent range. Note that this is the annual expected inflation rate for the next 10 years. Investors still expect prices to rise over this longer run, but they are not expecting them to rise too rapidly over this period.
Constraining economic growth, in my mind, is the restructuring that is going on in the economy. This fact is captured by the low rate of capacity utilization that exists in manufacturing and the low rate of labor participation.
Capacity utilization has declined in a secular fashion since the late 1960s, and indicates that a lot of the existing capacity is out of date and adjustments need to be made to meet the new technology.
The labor force participation rate has not been this low since the 1970s. There are a lot of people that have left the labor force or are underemployed, and this seems to be the new normal for this period of time. More and more employers are seemingly relying on part-time workers, and this seems to be the wave of the future.
So economic growth is picking up modestly, but will not be robust in this recovery. Economic growth will not become robust at this time because of the restructuring that needs to be done, and it will take time for the manufacturing world to transition to a structure appropriate for the 21st century, and it will take time for the labor force to adjust to the needs of a world driven by information technology.
In terms of monetary policy, there is little or nothing that the Federal Reserve can do, in my estimation, to increase capacity utilization or to increase the labor force participation rate. If anything, the Federal Reserve and the federal government, during the previous 50 years of credit inflation, have helped to postpone the economic restructuring that was needed, because their economic policies were aimed at putting unemployed people and unused capacity back to work in "legacy" work, which has tended to postpone the adjustments that were needed.
The Federal Reserve, therefore, has no reason not to continue its "tapering" of security purchases.
Taking off another $10 billion from its monthly rate of acquisition will bring the monthly level of security purchases down to $45 billion per month.
This amount, to me, is still excessive, because to continue on a monthly reduction of $10 billion per month until we get to zero purchases, will still add another $125 billion to the Fed's security portfolio over the next five months. This seems excessive.
The banking system seems to be pretty stable. Bank closures are minimal now, and the rate of consolidation of the banking system still points to a decline of about 200 banks this year.
Loan demand remains relatively weak, effective loan rates continue to drop, and there is absolutely no pressure in the money markets, especially in the market for Federal Funds, for short-term interest rates to rise.
The mergers and acquisitions business has been picking up, requiring bank loans, and other borrowing by hedge funds and private equity funds seems to be relatively strong, but these loans are going into uses that do not spark economic growth and hiring. If anything, they result in industry consolidation and the rationalization of hiring.
Corporate cash accumulations continue to rise, while more firms seem to be increasing their stock buybacks... or increasing their dividends.
In this environment, the Federal Reserve needs to get itself back into a position where it can function in a more normal way… more like it used to perform. There is little it can do right now to spur on economic growth or to lower unemployment. The financial system is adjusting, and is adjusting smoothly. Price inflation does not seem to be a worry on the near-term horizon, although all the liquidity around can result in some credit bubbles.
So the Federal Reserve needs to back off. The worry among Fed officials is that they do not want to create disruptions to the financial system or to the economy as the Fed does back off. Therefore, these officials will be cautious as they try to get back into a position to deal with more "normal" conditions.
For the near future, I don't believe that they will have to be dealing with rising short-term interest rates. The demand side of the market just seems to be too weak to cause much pressure to arise here. Longer-term interest rates will rise in this environment, and the Federal Reserve will just have to "not worry" and let them reach their own level. These rising longer-term interest rates should not hinder the economic recovery.
Still, there are a lot of unknowns out there, and any one of a number of events could change the picture dramatically. Here, I am talking about the economic situation in Europe, in China and elsewhere. Oh, and there are the situations in Ukraine, in Syria, in North Korea, or in… you name it.