Every couple of months I revisit my set of baseline expectations for the U.S. economy. This helps me gauge the importance of incoming data and events. This is the bones of the framework I have in mind:
1) Overly pessimistic or optimistic forecasts continue to fare poorly. To be sure, this depends on your definitions of optimistic and pessimistic, but I continue to think the path of GDP growth is notable for its relative stability over recent quarters:
(Click on charts below to enlarge)
2) The same story holds for the labor market. Interestingly, the 6 and 12 month averages for nonfarm payroll gains roughly converged with last months 163k gain:
With the economy growing at around 2%, payrolls increase around 150k per month. Not great, by some measures not a disaster.
3) I don't expect significant deviations from points one and two in the near-term. I tend to see the recent spate of weaker data that the Federal Reserve concluded from meant that
information received since the Federal Open Market Committee met in June suggests that economic activity decelerated somewhat over the first half of this year.
This is further evidence that the Fed's much-anticipated acceleration is simply not in the cards. Indeed, the Federal Reserve's June forecasts for GDP growth stood in the 1.9-2.4% and 2.2-2.8% ranges (central tendency) for 2012 and 2013. I anticipate these will come down a notch in the next forecast. In other words, the Fed's forecast will be about or slightly above 2% for the next two years. That acceleration just keeps getting pushed further into the future.
4) I see multiple reasons to expect soft growth figures. Government spending is a clear drag:
Some of the pent up demand in capital goods and auto spending has been satisfied:
Consumer spending has slowed:
5) From my perspective, housing looks set to support growth. Low inventories will support higher prices and, eventually, construction. To be sure, I would be hesitant to get carried away on this point. Plenty of negatives exist - tighter underwriting standards, shadow inventory, and sustained lower home ownership rates. And I don't expect the same wealth effect we saw at the height of the housing bubble. But the momentum appears to be moving in the right direction, which should mean that housing, on average, continues to support growth.
6) I remain concerned that even with housing improving, the stage is set for continued tepid growth, which means a persistent output gap:
And poor labor market outcomes, such as a slow decline in the unemployment rate:
high long-term unemployment:
and low wage growth:
On the upside, temporary hiring continues to grow, which is typically a positive signal:
I don't see sustaining high inflation in the absence of much higher wage growth. And the economy just will not support such wage growth. And wage growth itself does not necessarily translate into higher prices. It could come at the expense of lower profit margins.
8) It seems like the risks are generally weighted to the downside. While Europe may avoid financial collapse, I don't think the economy on the other side of the Atlantic will come surging back anytime soon. That seems guaranteed by the ongoing efforts to form an "austerity union" in the eurozone. Moreover, we seem to face ongoing uncertainty about the path of fiscal policy next year; I believe that a premature tightening of fiscal policy would be ill-advised. On the upside, the housing market may provide more of a broad-based improvement than my baseline expectations.
9) The combination of points 1-8 should lead to more aggressive monetary easing. The economy continues to settle into a path that is not consistent with either part of the Fed's dual mandate. Moreover, there are very real downside risks to even a tepid outlook.
10) Point 9 has been true for months, and at least three FOMC meetings. This is frustrating. What in the world is the point of making a big claim to affirm the nature of the dual mandate and then subsequently ignore any forecasts that indicate you have no faith the elements of the dual mandate will be met anytime soon?
11) There is clear support within the FOMC for additional easing, including open-ended quantitative easing. This is a positive development. Some FOMC members would even support a nominal GDP target and/or inflation greater than 2%. That said, I don't think the center (and certainly the hawks) would support higher inflation targets. Moreover, I am not yet sure that Federal Reserve Chairman Ben Bernanke is ready to pull the middle to the doves; he seems content to pull the middle to the hawks. Primarily, this reflects uncertainty about the effectiveness of additional quantitative easing. There appears to be a push to look for alternatives, perhaps to tools that will more directly channel funds to borrowers. Until Bernanke is willing to accept the need for additional policy, the Fed will remain on hold. There may or may not be a political element to Bernanke's resistance, despite claims to the contrary.
12) Bernanke could switch gears by the next meeting, or not until next year, or never, if the data shifts back toward optimistic. I would like to believe that the doves are sending us a signal that easing is coming soon, but that signal has not been very accurate for the last three meetings. The key is Bernanke, and he seems resistant to additional action until the data turn more decisively downward. I am not sure that will happen by the September meeting.
This isn't meant to be a complete analysis. To be sure, plenty of details are left out (the numbers are rough estimates), with missing pieces on both sides of the outlook. Instead, just a skeleton I can put more meat on later. And something by which to judge incoming data or policy shifts, such as a more aggressive monetary policy. And something to poke holes in as time goes on. I can convince myself of more positive and negative outcomes, but still keep coming back to the middle ground.