RCF Vice President Peter Bernstein is a member of the Philadelphia Federal Reserve Society of Professional Forecasters.
Near Term Outlook is Solid; Longer-Term Things Get Dicey
The economy grew at a 2.3 percent rate in 2017, an improvement from 2016’s 1.5 percent growth but not much more than the 2.0 percent average growth since the Great Recession. However, if one excludes the weak first quarter of the year, the economy grew close to 3.0 percent for the remainder of 2017, a pace that we expect to continue into 2018. In addition to cyclical momentum and solid growth around the world, the US economy will be boosted by tax cuts received by most individuals and businesses.
The tax cuts come at a cost, namely, higher budget deficits. And stronger consumer spending is likely to push up inflation. The hope is that both of these negatives can be mitigated by increases in economic output. For that to happen, one of two things must grow faster – employment or productivity. We are skeptical that employment will grow faster than it has and in fact project it to slow for the simple reason that low unemployment means there are fewer and fewer unemployed people to put to work. While there are many workers who have dropped out of the labor force and are not included in the official definition of employment, we have our doubts as to whether many of them will return to work after, in many cases, years removed from the labor market.
There is a greater chance of increases in productivity which has been notably weak in the last few years. Increases in business investment could boost productivity gains though it could also cause firms to substitute machinery for labor offsetting some of the contribution to economic growth. In sum, we are not convinced that the economy can really sustain long-term growth of 3.0 percent.
Instead, we see the fiscal stimulus from tax cuts providing mostly a short-term boost that will be
“paid for” with slower growth in the future. Accordingly, we project the economy to grow 2.9 percent in 2018 and 2.6 percent in 2019 but see only 1.1 percent growth in 2020. Moreover, we wouldn’t be surprised if the economy slipped into recession by then. The big concern for us is higher interest rates. The 10-year Treasury yield has already climbed to its highest level in four years and we see further increases in the future. Eventually, we think these higher rates will substantially dampen consumer and business spending.