united states economic forecast...sources historical data bureau of economic analysis, sourced from...

United States Economic Forecast2nd Quarter 2018

US Economic Forecast

AUTHORS

Dr. Daniel Bachman is a senior manager for US macroeconomics at Deloitte Services LP.

Dr. Rumki Majumdar is a macroeconomist and a manager at Deloitte Research, Deloitte Services LP.

CONTRIBUTORS

Dr. Ira Kalish is chief global economist for Deloitte Touche Tomatsu Limited.

Dr. Patricia Buckley is director of economic policy and analysis for Deloitte Services LP.

ABOUT THE AUTHORS

Contents

Introduction | 2

Sectors | 4

Consumer spending 4

Housing 5

Business investment 6

Foreign trade 8

Government 10

Labor markets 11

Financial markets 13

Prices 14

Appendix | 16

Endnotes | 20

2nd Quarter 2018

1

THE Fed is wrestling with this question as it watches the unemployment rate sink lower and lower with wages hardly budging and

little indication of the labor market reaching equi-librium.2 Just how low is a “normal” unemployment rate? Fed officials have offered steadily falling an-swers to that question. In March 2014, more than half of Federal Open Market Committee (FOMC) participants expected the long-run level for the un-employment rate to stay between 5.2 and 6.0 per-cent.3 Four years later, FOMC projections saw most participants forecasting the long-run rate to hover between 4.2 and 4.8 percent.4

Financial markets are struggling to determine what normal interest rates should be. If normal was the world before the Great Recession, the 10-year Treasury yield should be about 130 basis points above the Fed funds rate, since that was the average from 1985 to 2007.5 In fact, economists in the Wall Street Journal Survey are forecasting a much lower spread. Is this a new normal?

Builders, real estate agents, and home buyers are struggling to understand what a normal housing market looks like. How many new houses can the country absorb? How difficult is it to get a mortgage (and should it be so hard)? Do younger people really prefer living in dense urban areas, or is that just a result of their difficulties in finding affordable sin-gle-family houses and financing for those houses?

The current tax and fiscal policy further com-plicates forecasting a return to normal. Congress passed a significant fiscal stimulus that will partially

reverse by 2020, creating a potential drag on growth in that year and the next.6 Is normal the economy under the stimulus, after the stimulus goes away ... or some theoretical idea that will always remain out of reach?

Our Deloitte forecast does, despite these linger-ing questions, assume that the economy will move toward normal, which we define as consistent with past historical behavior. Though our scenarios ex-plore some of the implications of different defini-tions of normal, the past remains the best source of knowledge about what the economy might be like in the future. It’s always a good idea to be skeptical that “this time is different.”

Scenarios

Our scenarios are designed to demonstrate the different paths down which the administration’s policies and congressional action might take the American economy. Foreign risks have not dissipat-ed, and we’ve incorporated them into the scenarios. But for now, we view the greatest uncertainty in the US economy to be that generated within the na-tion’s borders.

The baseline (55 percent probability): Consumer spending continues to grow. A pickup in foreign growth helps to tamp down the dollar and increase demand for US exports, adding to demand. Fiscal stimulus from the tax cut bill and the budget agreement pushes growth up to close to 3.0 per-

IntroductionWhy be normal?

Normalcy. The word wasn’t invented by President Warren G. Harding, as some people claim.1 But it caught on in a country anxious to settle down after the chaos of the Great War. Today, everybody is anxious to finally move on from the experience of the financial crisis and the subsequent slow recovery, and to see the economy return to normal. But that creates a question: What is normal?


2

cent in 2018 and above 2.5 percent in 2019. With the economy near full employment, the faster GDP growth creates inflationary pressures. The Fed re-sponds with an aggressive interest-rate policy, and long-term rates rise quickly as alternative assets (abroad) become more appealing. A small increase in trade restrictions adds to business costs in the medium term, but this is offset by lower regulatory costs. As the impact of stimulus fades and the econ-omy feels the effect of higher interest rates, growth slows below potential in 2020 and ’21.

Recession (15 percent): Dubious policy and financial market decisions in the United States, Eu-rope, and China trigger a global financial crisis. The Fed and the European Central Bank act to ease con-ditions, and the financial system recovers relatively rapidly. GDP falls in the fourth quarter of 2018 and first two quarters of 2019, and then recovers.

Slower growth (20 percent): Business tax cuts induce little investment spending, while

households save their tax cuts. Meanwhile, the ad-ministration places significant restrictions on US imports, raising costs and disrupting supply chains. Businesses hold back on investments to restructure their supply chains because of uncertainty about fu-ture policy. The higher spending authorization from the budget bill translates only slowly into additional federal outlays, reducing the budget bill’s impact on the economy. GDP growth falls to less than 1.5 per-cent over the forecast period, while the unemploy-ment rate rises to about 6.0 percent.

Productivity bonanza (10 percent): Tech-nological advances in manufacturing begin to lower corporate costs, as deregulation improves busi-ness confidence. Improved infrastructure boosts demand in the short run and, in the long run, ca-pacity and the productivity of private capital. The economy grows 3.5 percent in 2018 and 2019, and growth stays above 2.0 percent between 2020 and 2022, while inflation remains subdued.

Deloitte Insights | deloitte.com/insightsSources: Historical data: Bureau of Economic Analysis, sourced from Haver Analytics. Forecasts: Deloitte, using the Oxford Global Economic Model.

-3

-2

-1

0

1

2

3

4

5Percent

Baseline Recession

Coordinated global recovery Continued slow growth

1995 2000 2005 2010 2015 2020

History Forecast

Figure 1. Real GDP growth

2nd Quarter 2018

3

Consumer spending

The household sector has provided an under-pinning of steady growth for the US economy over the past few years. Even while business investment was weak, exports faced substantial headwinds, and housing stalled, consumer spending grew steadily. But that’s unsurprising, since job growth has been quite strong. Even with relatively low wage growth, those jobs have helped put money in consumers’ pockets, enabling households to continue to increase their spending. The continued steady (if modest) growth in house prices has helped, too, since houses are most households’ main form of wealth.

For all the daily speculation about how political developments might affect consumer choices when it comes to spending decisions, political noise seems to be just that—in the background—to consumers

who seem focused on their own situations. As long as job growth holds up and house prices keep ris-ing, consumer spending should remain strong. And the tax cut, while modest for most consumers, will likely bolster their confidence that they can safely spend, notwithstanding a dip in 2018 Q1.7 More im-portantly, the tax bill’s fiscal stimulus may tighten the job market even further. If wages begin to rise, consumer spending is likely to get a further boost.

The medium term presents a different picture. Many American consumers spent the 1990s and ’00s trying to maintain spending even as incomes stagnated. But now they are wiser (and older, which is another challenge, as many baby boomers face im-minent retirement with inadequate savings8). That may constrain spending and require higher savings in the future. That could be a shock, since a key fea-ture of the current consumer boom is a decline in

Sectors


12

4

0

-4

8

-8

16Percent

Durables Services Nondurables

1995 2000 2005 2010 2015 2020

History Forecast

Figure 2. Consumer spending growth


4

the savings rate (from an average of 6.1 percent in 2015 to just 2.6 percent at the end of 2017, although the savings rate ticked up in 2018 Q1).

Although American households seem to face fewer obstacles in their pursuit of the “good life” than just a few years ago, growing income inequal-ity poses a significant challenge for the sector’s long-run health. For instance, low unemployment hasn’t alleviated many people’s economic insecu-rity: Four in 10 adults would be able to cover an unexpected $400 expense only by borrowing mon-ey or selling something.9 For more about inequal-ity, see Income inequality in the United States: What do we know and what does it mean?,10 Deloitte’s most recent examination of the issue.

Housing

Every year, thousands of young Americans aban-don the nest and start their own households. But more than usual stayed put after the recession: The number of households didn’t grow nearly enough to account for all the newly minted young adults. We expect those young adults would prefer to live on their own and create new households; as the econ-omy continues to recover, they will likely do exactly that—as previous generations have.

This should mean some positive fundamentals for housing construction in the short run. Since 2008, the United States has been building fewer new housing units than the population would normally require; in fact, housing construction was hit so hard that the oversupply turned into an undersup-ply. But the hole is shallower than one might think with several factors offsetting each other. House-hold size has stabilized after falling for several years. If it starts falling again—something to be expected as the population ages—the demand for housing would rise. The vacancy rate is still a bit higher than the historical norm, so there is some room for demand to be absorbed by filling vacant housing units.

Our best guess, based on a model of the hous-ing market,11 is that there is room for a short-term boom in housing construction, to levels of perhaps 1.35 million units per year. A couple of years of hous-ing starts at this level would fill any pent-up demand, leaving only the need for perhaps 1.1 million units, the number we estimate would meet demand in the medium term. This means that our forecast includes a small boom in the housing market, followed by several years of slowly declining construction. For the economy as a whole, that is not a major prob-lem—housing remains a smaller share of GDP than it reached during the housing boom before the Great Recession.

Table 1. Consumer spending growth

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Real consumer spending 1.5 1.5 2.9 3.6 2.7 2.8 2.5 2.4 1.2 1.0 1.2 1.3

Real consumer spending, durable goods

7.4 6.2 6.9 7.8 5.5 6.7 4.3 2.3 1.9 1.7 1.7 1.8

Real consumer spending, nondurable goods

0.6 1.7 2.5 3.1 2.8 2.4 2.5 2.4 1.0 0.9 1.2 1.2

Real consumer spending, services

0.8 0.6 2.4 3.2 2.3 2.2 2.3 2.5 1.2 1.0 1.1 1.3

Net household wealth ($ trillions) 44 51 55 56 60 65 67 66 66 67 70 72

Unemployment rate 8.1 7.4 6.2 5.3 4.9 4.4 3.9 3.9 4.2 4.4 4.4 4.5

Consumer price index 2.1 1.5 1.6 0.1 1.3 2.1 2.7 2.1 1.8 1.9 2.1 2.0

Sources: Historical data: US government agencies and Oxford Economics. Forecast: Deloitte, using the Oxford Global Economic Model. Deloitte Insights | deloitte.com/insights

2nd Quarter 2018

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https://www2.deloitte.com/insights/us/en/economy/issues-by-the-numbers/july-2017/rising-income-inequality-gap-united-states.html

https://www2.deloitte.com/insights/us/en/economy/issues-by-the-numbers/july-2017/rising-income-inequality-gap-united-states.html

Business investment

The key question for business investment in the next year or so is the impact of the tax reform bill, which contained four main components that could affect business investment at the aggregate level.

• Congress cut the tax rate for businesses from 35 percent to 21 percent but eliminated a number of corporate tax breaks. Some companies will benefit more from the lower tax rates; others that depended on specific tax deductions may find their cost of capital to be higher than before the bill passed.


Figure 3. Housing

2,000

1,200

800

600

1,600

400

2,200

1,800

1,000

1,400

15

-5

-15

-20

5

-25

20

10

-10

0

Million Percent change

Housing starts (left axis) Residential construction (right axis)

1995 2000 2005 2010 2015 2020

History Forecast

Table 2. Housing

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Real investment in private housing 13.5 11.9 3.5 10.2 5.5 1.8 3.7 -0.9 -5.7 -3.5 -2.6 -1.5

Housing starts (millions) 0.78 0.93 1.00 1.11 1.18 1.21 1.35 1.31 1.21 1.18 1.14 1.11

Stock of houses (millions) 133 133 134 135 136 137 138 138 139 140 141 142

30-year fixed mortgage rate (percent)

3.66 3.98 4.17 3.85 3.65 3.99 4.61 5.08 5.57 6.01 6.15 6.29



6

• The bill allows businesses to bring back earnings from foreign operations at lower tax rates (repa-triation), which is unlikely to have a large impact on business spending—after all, if companies needed cash, they could have easily borrowed it, at historically low rates. In other words, the geo-graphical location of the assets on the balance sheet is unlikely to drive corporate decision-making.

• A temporary provision allows for accelerated expensing of investments. Though the pro-vision is phased out after 2022 (beyond our forecast horizon), there is some evidence that it will temporarily lift investment spending—possibly substantially.12

• The bill could increase corporate cash flow be-cause the offsetting payments (from taxing re-patriation of earnings and reducing corporate deductions) are less than the impact of lowering the tax rate. The tax reform bill essentially leaves more cash on corporate balance sheets, which

may induce additional investment spending—or more stock buybacks and/or increased dividends.The impact of the tax reform may be less than

past experience suggests, however. Taxes affect in-vestment decisions through the cost of capital, which also depends on interest rates and the depreciation rate. But the cost of capital has been at historic lows over the past decade, and many businesses have remained reluctant to take advantage to raise invest-ment. So cutting the cost of capital further may have at best a modest impact. Our forecast assumes that additional investment spending adds several tenths of a percentage point to growth in 2018 and ’19.

However, some CEOs may face a painful medium-term dilemma: deciding whether their businesses need to rebuild their supply chains. Industries such as automobile production have developed intricate networks across North America and are reaching into Asia and Europe, based on the longstanding assumption that materials and parts can be moved across borders with little cost or disruption. These


Figure 4. Business sector

20

0

-10

10

-20

30Percent

Corporate profits Real nonresidential investment

1995 2000 2005 2010 2015 2020

History Forecast

2nd Quarter 2018

7

capital-intensive industries may want to postpone easily delayed investments in these networks until the administration’s trade policy becomes clearer.13

One industry in particular—energy—is investing heavily right now. Relatively high oil prices have convinced energy producers to put more drilling rigs to work, with follow-up demand for all the par-aphernalia of today’s high-tech energy exploration business. Total business investment may register some impressive numbers because of this—at least until the price of oil crashes once again.

Foreign trade

Over the past few decades, business—especially manufacturing—has taken advantage of gener-ally open borders and cheap transportation to cut costs and improve global efficiency. The result is a complex matrix of production that makes the tradi-tional measures of imports and exports somewhat misleading. For example, in 2017, 37 percent of Mexico’s exports to the United States consisted of intermediate inputs purchased from . . . the United States.14

Recent events appear to be placing this global manufacturing system at risk. The United Kingdom’s increasingly tenuous post-Brexit position in the Eu-ropean manufacturing ecosystem, along with the suggestion that the United States might cancel or renegotiate its position in the North American Free Trade Agreement,15 may slow the growth of this

system or even cause it to unwind. The US trade ne-gotiations with China also threaten the system, as American companies may have to quickly reconfig-ure their relationships with Chinese suppliers.

In the short run, uncertainty about border-crossing costs may reduce investment spending. Businesses may be reluctant to put capital in place when facing the possibility of a sudden shift in costs.

A significant change in border-crossing costs—as would occur if the United States withdrew from NAFTA—could potentially reduce the value of capi-tal investment put in place to take advantage of global goods flows. Essentially, the global capital stock could depreciate more quickly than our normal measures would suggest. In practical terms, some US plants and equipment could go idle without the ability to access foreign intermediate products.

With this loss of productive capacity would come the need to replace it with plants and equipment that would be profitable at the higher border cost. We might expect gross investment to increase once the outline of a new global trading system becomes apparent.

In the longer term, a more protectionist en-vironment will likely raise costs. That’s a simple conclusion to be drawn from the fact that global-ization was largely driven by businesses trying to cut costs. How those extra costs are distributed depends a great deal on economic policy—for example, central banks can attempt to fight the impact of lower globalization on prices (with a resulting period of high unemployment) or to

Table 3. Business

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Real fixed business investment

9.0 3.5 6.9 2.3 -0.6 4.7 5.4 5.1 2.5 3.3 5.2 6.7

Real inventory investment ($ billions)

54.7 78.7 67.8 101 33.4 15.2 34.2 45.1 26.8 15.1 23.8 26.3

Employment cost index 1.9 1.9 2.1 2.1 2.2 2.5 2.9 3.5 2.5 1.5 2.0 2.6

After-tax corporate profits 10.0 1.7 5.3 -1.1 -2.1 4.4 6.9 5.3 -0.8 3.4 5.6 2.3

Yield on 10-year Treasury note 1.80 2.35 2.54 2.14 1.84 2.33 2.94 3.35 3.56 3.87 3.97 4.00



8

Table 4. Foreign trade

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Real exports of goods and services

3.4 3.5 4.3 0.4 -0.3 3.4 4.1 2.7 2.1 2.3 3.2 3.6

Real imports of goods and services

2.2 1.1 4.5 5.0 1.3 4.0 5.0 3.6 -0.7 0.6 1.9 5.5

Current account balance (share of GDP)

-2.6 -2.1 -2.1 -2.4 -2.4 -2.4 -3.0 -3.2 -2.7 -2.4 -2.2 -2.5

Merchandise trade balance ($ billions)

-730 -690 -727 -737 -735 -797 -677 -951 -881 -844 -842 -964

Relative unit labor costs (index, 2008=100)

87.6 85.4 89.2 98.5 101.0 100.4 96.3 94.9 94.6 94.0 93.0 92.1



Figure 5. International trade

20

4

-4

-12

12

-20

24

16

0

-16

-8

8

Percent $ billion

1995 2000 2005 2010 2015 2020

History Forecast

Merchandise trade balance (right axis)Exports (left axis) Imports (left axis)

-200,000

-600,000

-800,000

-900,000

-400,000

-1,000,000

-100,000

-300,000

-700,000

-500,000

-1,100,000

accommodate it (allowing inflation to pick up).

The current account is determined by global financial flows, not trade costs.16 Any potential re-duction in the current account deficit is likely to be

largely offset by a reduction in American competi-tiveness through higher costs in the United States, lower costs abroad, and a higher dollar. All four sce-narios of our forecast assume that the direct impact of trade policy on the current account deficit is nil.

2nd Quarter 2018

9

Government

Markets—and other business decision-makers—are still assimilating the remarkable government policy changes that occurred around the end of 2017 and beginning of 2018. First, Congress passed a comprehensive tax reform package, including a substantial tax cut. Second, Congress agreed to a budget proposal for the next two years, remov-ing uncertainty about funding the government through FY 2019 (which ends in September 2019) and the debt ceiling (which was raised until March 1, 2019).17 These acts seem to substantially reduce the near-term risk of a financial crisis related to a US government shutdown or inability to borrow to meet current financing needs.

The Deloitte forecast assumes that the two bills together will provide substantial short-term stimu-lus to the US economy, raising growth in 2018 and

’19 but causing growth to slow afterward as the stimulus is removed. The impact on the economy’s

capacity in the long run remains a matter of debate, with estimates ranging from no real change after a decade (Tax Policy Center) to 2.8 percent, or almost 0.3 percentage points annually (Tax Foundation).18

Prospects for an infrastructure spending pack-age are becoming less likely, even though the successful passage of the tax and budget legislation suggests that—should congressional leadership pri-oritize infrastructure—there may still be a window of opportunity for some type of bill.19 Our baseline assumes no infrastructure plan,20 while the produc-tivity bonanza scenario assumes some additional government spending (as well as additional produc-tivity from these investments in the medium and long run).

After years of belt-tightening, many state and local governments are no longer actively cutting spending. However, many state budgets remain constrained by questions around the effects of new federal tax policy21 and the need to meet large un-funded pension obligations,22 so state and local


Figure 6. Government sector

6

2

0

-2

4

-4

-6

8Percent

All government Federal State and local

1995 2000 2005 2010 2015

History

-82020

Forecast


10

spending growth will likely remain low over this forecast’s five-year horizon.

Pressure is building for increased spending in education, as evidenced by the recent public teacher protests in several states.23 With education costs accounting for about a third of all state and local spending, a significant upturn in this category could create some additional stimulus—or require an in-crease in state and local taxes.

Labor markets

If the American economy is to effectively pro-duce more goods and services, it will need more workers, and many potential employees remain out of the labor force, having left in 2009, when the labor market was challenging. But they are return-ing. The labor force participation rate for prime-age workers has been rising since the middle of 2015. At 73.5 percent (in March), it’s still a couple of percent-age points below the level of the mid-2000s.24 But that may mean that there are more workers who can be enticed back into the labor market as condi-tions improve, and our baseline forecast reflects that possibility.

Meanwhile, the labor force participation rate for over-65s has flattened out. It’s still much higher than the historical average—and it is certainly pos-sible that, with better labor market conditions, more

over-65s can be enticed back into the labor force as well.

But a great many people are still on the sidelines and have been out of steady work for years—long enough that their basic work skills may be eroding.25 Are those people still employable? So far, the answer has been “yes,” as job growth continues to be strong without pushing up wages. Deloitte’s forecast team remains optimistic that improvements in the labor market will prove increasingly attractive to poten-tial workers, and labor force participation is likely to continue to improve accordingly.

Despite this, demographics are slowing the growth of the population in prime labor force age. As boomers age, lagging demographic growth will help slow the potential growth of the economy. That’s why we foresee trend growth just a bit above 1.5 percent by 2021: Even with an optimistic view about productivity, we expect that slow labor force growth will eventually be felt in lower economic growth.

Significant immigration restrictions and/or de-portation might have a marginal impact on the labor force. According to the Pew Research Center, un-documented immigrants make up about 5.0 percent of the total American labor force.26 Removal of all such workers would clearly have a significant impact on the labor force and on the economy—but such a dramatic, disruptive change is unlikely to happen. Any mass removal of undocumented workers could

Table 5. Government

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Real government consumption and investment

-1.9 -2.9 -0.6 1.4 0.8 0.1 2.5 3.5 -0.5 -1.1 0.1 0.5

Real federal government consumption and investment

-1.9 -5.8 -2.4 -0.1 0.0 0.2 6.0 9.1 -2.9 -5.3 -2.1 -1.0

Real state and local government consumption and investment

-1.9 -0.8 0.5 2.3 1.2 0.1 1.4 1.4 1.3 1.2 1.2 1.2

Federal budget balance, unified basis (share of GDP)

-7.3 -4.3 -2.9 -2.6 -2.9 -3.5 -4.1 -5.4 -5.7 -5.9 -6.0 -6.3


2nd Quarter 2018

11


Figure 7. Labor market

10

6

4

8

3

11

9

5

7

200

-200

-400

0

-500

300

100

-300

-100

Percent Thousands

Average monthly job gain (right axis)Unemployment rate (left axis)

1995 2000 2005 2010 2015 2020

History Forecast

Table 6. Labor market

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Average monthly change in employment (thousands)

186 183 214 240 211 190 211 152 105 79 67 35

Unemployment rate (percent) 8.1 7.4 6.2 5.3 4.9 4.4 3.9 3.9 4.2 4.4 4.4 4.5

Employment to population ratio (percent)

45% 46% 46% 46% 47% 47% 48% 48% 48% 48% 48% 48%



create labor shortages in certain industries, such as agriculture, in which some 17 percent of workers are unauthorized,27 and construction, in which an

estimated 13 percent of workers are unauthorized.28 But it would likely have little significant impact at the aggregate level.


12

Financial markets

Interest rates are among the most difficult eco-nomic variables to forecast because movements depend on news—and if we knew it ahead of time, it wouldn’t be news. The Deloitte interest rate forecast is designed to show a path for rates consistent with the forecast for the real economy. But the potential risk for different interest rate movements is higher here than in other parts of our forecast.

The forecast sees both long- and short-term interest rates headed up—maybe not this week, or this month, but sometime in the future. Fed officials are clearly concerned about the possibility of the economy overheating: The January Federal Open Market Committee minutes noted that “participants… anticipated that the rate of economic growth in 2018 would exceed their estimates of its sustainable lon-ger-run pace.” This was before Congress passed the

large spending stimulus in February. Any signs of incipient acceleration in inflation will likely elicit a strong response by the Fed.

We expect the Fed to continue to hike short-term interest rates at every second FOMC meeting for the next two years, and to continue to let its inventory of short-term assets shrink at a slow rate. Our esti-mate of the Fed’s view of the “neutral rate”—the rate that is consistent with full employment and stable inflation—stands at 3.2 percent. However, some Fed officials are discussing a lower “neutral rate.” FOMC members’ central estimate for the longer-run value of the Fed funds rate is, in fact, 2.8 to 3.0 percent,29 so our forecast is a little higher than the Fed’s.

As the economy approaches full employment and the possibility of higher inflation increases, long-term interest rates will rise as well—and perhaps even rise faster. The improvement in foreign eco-nomic conditions will play an important role as well.


Figure 8. Financial markets

7

5

4

3

6

2

1

0

8Percent

Federal funds rate 10-year Treasury yield

1995 2000 2005 2010 2015 2020

History Forecast

2nd Quarter 2018

13

The continuing European recovery, in particular, could draw investors away from the United States and toward higher returns in Europe. (Provided, of course, that the Italian political situation does not create a financial crisis in the eurozone.30) That’s not necessarily a bad thing, as slow European growth has been a significant challenge for the global econ-omy, as well as for US exports. But the European recovery will help to hasten the return of long-term interest rates to a more “normal” rate.

Many forecasters believe that this “normal” rate will be around 3.5 percent. At a Fed funds rate of around 3.0 percent, that would suggest an equi-librium value of the spread between the Fed funds rate and the 10-year note yield of just half a percent. That’s historically very low. The average spread over the postwar period has been about 1.0 percent, and that includes the time during recessions when the spread shrinks to almost nothing or even goes negative. The normal spread is therefore certainly above 1.0 percentage point, implying that a 3.0 per-cent fund rate would be consistent with a 10-year Treasury yield over 4.0 percent. Between 2002 and 2006, the spread averaged almost 2.0 percent. If the spread moves that high, long-term rates could easily hit 5.0 percent or more.

Prices

It’s been a long time since inflation has posed a problem for American policymakers. Could inflation break out as the economy reaches full employment? Economists are increasingly wondering about this, as it becomes evident that something is amiss in

the standard inflation models. These models posit that, since labor accounts for about 70 percent of business costs, the state of the labor market should drive overall inflation. US labor markets appear to be tightening—but labor costs remain fully under control. As long as businesses don’t face increasing costs, it’s hard to see what would drive a sustained rise in goods and services prices.

But it’s also quite possible that the economy simply hasn’t hit full employment. Despite unem-ployment dipping below 4.0 percent, the labor force participation rate for prime-age workers remains about two points below the rate before the financial crisis. Two percent of the prime working-age pop-ulation suggests that about 4 million more people could be enticed into the labor force under the right conditions. Whether those people are really avail-able is unclear, and economists are debating the issue fiercely.31 The combination of low labor-cost growth and continued high employment growth suggests that people are indeed being enticed back into the labor market.

At some point, however, the combination of the tax cut and spending increase could create some shortages in both labor and product markets and, as a result, some inflation. A return to 1970s-style inflation is about as likely as a return to bell-bot-tom jeans. But it would not be surprising in those circumstances to see the core CPI rise to above 2.5 percent. Our forecast expects timely Fed action to prevent inflation from rising too much, but the price (of course) is higher interest rates. Higher inflation rates are now a significant risk because of the size of the stimulus being applied to the economy this year.

Table 7. Financial markets

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Federal funds rate 0.13 0.13 0.13 0.14 0.39 0.97 1.79 2.79 3.17 3.17 3.17 3.17

Yield on 10-year Treasury bill 1.80 2.35 2.54 2.14 1.84 2.33 2.94 3.35 3.56 3.87 3.97 4.00

Interest rate on 30-year fixed-rate mortgage

3.66 3.98 4.17 3.85 3.65 3.99 4.61 5.08 5.57 6.01 6.15 6.29




14


Figure 9. Prices

4

2

1

3

0

5

Percent

CPI Employment cost index

1995 2000 2005 2010 2015 2020

History Forecast

Table 8. Prices

History Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Chained GDP price index 1.8 1.6 1.8 1.1 1.3 1.8 2.1 2.2 2.0 1.8 1.8 1.8

Consumer price index 2.1 1.5 1.6 0.1 1.3 2.1 2.7 2.1 1.8 1.9 2.1 2.0

Chained price index for personal consumption expenditures

1.9 1.3 1.5 0.3 1.2 1.7 2.3 2.1 1.6 1.8 2.0 2.0



2nd Quarter 2018

15

Table 1. Baseline

History Forecast% change, year over year, unless noted otherwise 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

GDP and componentsReal GDP 2.2 1.7 2.6 2.9 1.5 2.3 2.9 2.7 1.1 1.0 1.6 1.5

Real consumer spending 1.5 1.5 2.9 3.6 2.7 2.8 2.5 2.4 1.2 1.0 1.2 1.3

Real consumer spending, durable goods 7.4 6.2 6.9 7.8 5.5 6.7 4.3 2.3 1.9 1.7 1.7 1.8

Real consumer spending, nondurable goods 0.6 1.7 2.5 3.1 2.8 2.4 2.5 2.4 1.0 0.9 1.2 1.2

Real consumer spending, services 0.8 0.6 2.4 3.2 2.3 2.2 2.3 2.5 1.2 1.0 1.1 1.3

Real investment in private housing 13.5 11.9 3.5 10.2 5.5 1.8 3.7 -0.9 -5.7 -3.5 -2.6 -1.5

Real fixed business investment 9.0 3.5 6.9 2.3 -0.6 4.7 5.4 5.1 2.5 3.3 5.2 6.7

Real inventory accumulation 55 79 68 101 33 15 34 45 27 15 24 26

Real exports of goods and services 3.4 3.5 4.3 0.4 -0.3 3.4 4.1 2.7 2.1 2.3 3.2 3.6

Real imports of goods and services 2.2 1.1 4.5 5.0 1.3 4.0 5.0 3.6 -0.7 0.6 1.9 5.5

Real government consumption and investment -1.9 -2.9 -0.6 1.4 0.8 0.1 2.5 3.5 -0.5 -1.1 0.1 0.5

Real federal government consumption and investment -1.9 -5.8 -2.4 -0.1 0.0 0.2 6.0 9.1 -2.9 -5.3 -2.1 -1.0

Real state and local government consumption and investment -1.9 -0.8 0.5 2.3 1.2 0.1 1.4 1.4 1.3 1.2 1.2 1.2

PricesConsumer Price Index 2.1 1.5 1.6 0.1 1.3 2.1 2.7 2.1 1.8 1.9 2.1 2.0

Chained price index for personal consumption expenditures 1.9 1.3 1.5 0.3 1.2 1.7 2.3 2.1 1.6 1.8 2.0 2.0

Chained GDP price index 1.8 1.6 1.8 1.1 1.3 1.8 2.1 2.2 2.0 1.8 1.8 1.8


Labor marketsAverage monthly change in employment (thousands) 186 183 214 240 211 190 211 152 105 79 67 35


Employment to population (percent) 58.6 58.6 59.0 59.3 59.7 60.1 60.6 60.8 60.9 60.7 60.5 60.2

Income and wealthReal disposable personal income 3.1 -1.4 3.6 4.2 1.4 1.2 2.3 2.2 1.8 1.1 1.1 1.5


Personal saving rate (percentage of disposable income) 7.6 5.0 5.7 6.1 4.9 3.4 3.1 3.0 3.6 3.6 3.6 3.8

After-tax corporate profits with inventory valuation and capital consumption adjustments 10.0 1.7 5.3 -1.1 -2.1 4.4 6.9 5.3 -0.8 3.4 5.6 2.3

HousingHousing starts (thousands) 784 928 1,001 1,107 1,177 1,208 1,351 1,306 1,214 1,178 1,145 1,108

Stock of owner-occupied homes (millions) 133 133 134 135 136 137 138 138 139 140 141 142

Interest rate on 30-year fixed-rate mortgages (percent) 3.66 3.98 4.17 3.85 3.65 3.99 4.61 5.08 5.57 6.01 6.15 6.29

Foreign tradeCurrent account balance, share of GDP (percent) -2.6 -2.1 -2.1 -2.4 -2.4 -2.4 -3.0 -3.2 -2.7 -2.4 -2.2 -2.5

Merchandise trade balance ($ billions) -730 -690 -727 -737 -735 -797 -677 -951 -881 -844 -842 -964

Relative unit labor costs (Index, 2008=100) 87.6 85.4 89.2 98.5 101.0 100.4 96.3 94.9 94.6 94.0 93.0 92.1

FinancialFederal funds rate (percent) 0.13 0.13 0.13 0.14 0.39 0.97 1.79 2.79 3.17 3.17 3.17 3.17

Yield on 10-year Treasury note (percent) 1.80 2.35 2.54 2.14 1.84 2.33 2.94 3.35 3.56 3.87 3.97 4.00

GovernmentFederal budget balance, unified basis (share of GDP, percent) -7.3 -4.3 -2.9 -2.6 -2.9 -3.5 -4.1 -5.4 -5.7 -5.9 -6.0 -6.3

Sources: Historical data: US government agencies and Oxford Economics. Forecast: Deloitte, using the Oxford Global Economic Model.

Appendix


16

Table 2. Coordinated global recovery







Real investment in private housing 13.5 11.9 3.5 10.2 5.5 1.8 3.6 -2.0 -4.7 -2.3 -2.6 -2.1




Real imports of goods and services 2.2 1.1 4.5 5.0 1.3 4.0 5.5 5.9 2.9 2.4 2.2 2.4



Real state and local government consumption and investment -1.9 -0.8 0.5 2.3 1.2 0.1 1.6 6.1 -1.8 0.0 1.2 1.1










Personal saving rate (percent of disposable income) 7.6 5.0 5.7 6.1 4.9 3.4 3.0 2.3 3.0 3.2 3.0 3.2






Merchandise trade balance ($ billions) -730 -690 -727 -737 -735 -797 -691 -1,019 -1,028 -980 -950 -977






2nd Quarter 2018

17

Table 3. Recession


GDP and componentsReal GDP 2.2 1.7 2.6 2.9 1.5 2.3 1.9 -1.1 1.9 2.0 1.6 1.6Real consumer spending 1.5 1.5 2.9 3.6 2.7 2.8 1.7 -0.7 1.6 1.8 2.0 1.9


Real consumer spending, nondurable goods 0.6 1.7 2.5 3.1 2.8 2.4 1.5 -1.0 1.5 1.8 2.0 1.8

Real consumer spending, services 0.8 0.6 2.4 3.2 2.3 2.2 1.3 -0.9 1.7 1.9 2.0 1.9

Real investment in private housing 13.5 11.9 3.5 10.2 5.5 1.8 2.1 -7.9 0.1 1.6 -3.2 -3.3

Real fixed business investment 9.0 3.5 6.9 2.3 -0.6 4.7 2.6 -5.0 5.9 6.4 4.9 5.8

Real inventory accumulation 55 79 68 101 33 15 25 -35 19 33 28 28

Real exports of goods and services 3.4 3.5 4.3 0.4 -0.3 3.4 2.3 -3.4 2.5 3.4 2.7 3.1

Real imports of goods and services 2.2 1.1 4.5 5.0 1.3 4.0 3.0 -3.8 3.5 3.5 3.8 5.4








Labor marketsAverage monthly change in employment (thousands) 186 183 214 240 211 190 64 -124 300 154 99 113






After-tax corporate profits with inventory valuation and capital consumption adjustments 10.0 1.7 5.3 -1.1 -2.1 4.4 6.4 -4.3 4.0 2.1 1.8 1.8





Merchandise trade balance ($ billions) -730 -690 -727 -737 -735 -797 -630 -800 -857 -873 -935 -1,054







18

Table 4. Slower growth







Real investment in private housing 13.5 11.9 3.5 10.2 5.5 1.8 1.6 1.4 -0.4 -2.1 -3.1 -1.9




Real imports of goods and services 2.2 1.1 4.5 5.0 1.3 4.0 3.8 1.9 0.6 1.0 1.6 3.6

Real government consumption and investment -1.9 -2.9 -0.6 1.4 0.8 0.1 2.4 2.1 -0.8 0.1 0.5 0.6


















Merchandise trade balance ($ billions) -730 -690 -727 -737 -735 -797 -653 -893 -855 -830 -832 -899






2nd Quarter 2018

19

1. Merriam-Webster, “Did Warren Harding coin ‘normalcy’?,” accessed May 30, 2018.

2. Patti Domm, “Super strong jobs report means June rate hike coming and Fed could get more aggressive,” CNBC, June 1, 2018.

3. Federal Reserve Board, “Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, March 2014,” March 19, 2014.

4. Federal Reserve Board, “Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents under their individual assessments of projected appropriate monetary policy, March 2018,” March 21, 2018.

5. Unless otherwise noted, all data supplied by Haver Analytics, which compiles statistics from the US Bureau of Labor Statistics, the Bureau of Economic Analysis, and other databases.

6. Rex Nutting, “The U.S. economy is fine now, but watch out for 2020, top economist says,” MarketWatch, April 10, 2018.

7. Ben Leubsdorf and Sharon Nunn, “U.S. GDP growth revised down to 2.2% rate in first quarter,” Wall Street Journal, May 30, 2018.

8. See, for example, US Government Accountability Office, “Retirement security: Most households approaching retirement have low savings,” May 12, 2015; Gaobo Pang and Mark J. Warshawsky, “Retirement savings adequacy of US workers,” SSRN, March 12, 2013.

9. Board of Governors of the Federal Reserve System, Report on the economic well-being of U.S. households in 2017, May 2018.

10. Daniel Bachman, Income inequality in the United States: What do we know and what does it mean?, Deloitte University Press, July 12, 2017.

11. See Daniel Bachman, Housing construction: What happens when the kids finally leave, Deloitte University Press, March 12, 2015.

12. See, for example, Eric Zwick and James Mahon, Tax policy and heterogeneous investment behavior, NBER Working Paper No. 21876, January 2016.

13. Shawn Donnan, “White House tariff move reignites US trade war with China,” Financial Times, May 29, 2018; Niv Elis, “Study: Auto tariffs would kill 157,000 jobs,” Hill, May 30, 2018.

14. Patricia Buckley, A new view of international trade, Deloitte University Press, March 17, 2014.

15. David Lawder and David Ljunggren, “Delays and ‘poison pills’: Team Trump runs out of road in NAFTA talks,” Reuters, May 29, 2018.

16. For a complete explanation, see Daniel Bachman, Balancing payments: Why it’s harder than you might think to cut the trade deficit, Deloitte University Press, February 28, 2017.

17. Jeremy Diamond and Jeff Zeleny, “Trump signs spending bill, blasts Congress,” CNN, March 23, 2018.

ENDNOTES


20

18. Tax Foundation, Preliminary details and analysis of the Tax Cuts and Jobs Act, Special Report No. 241, December 2017; Benjamin R. Page et al., Macroeconomic analysis of the Tax Cut and Jobs Act, Tax Policy Center, December 20, 2017. For two other views (that estimate the impact at about 0.1 percent per year), see Joint Committee on Taxation, Macroeconomic analysis of the conference agreement for H.R. 1, the “Tax Cuts and Jobs Act,” December 22, 2017, and Penn Wharton Budget Model, The Tax Cuts and Jobs Act, as reported by conference committee (12/15/17): Static and dynamic effects on the budget and economy, December 18, 2017.

19. Mallory Shelbourne, “Trump’s infrastructure plan hits a dead end,” Hill, May 17, 2018.

20. If and when legislation does make it to the House and Senate floors, the administration’s infrastructure proposal suggests that cost-sharing would be a key component of any infrastructure bill. That would likely reduce that bill’s economic impact. See Hill, “Read Trump’s $1.5T infrastructure spending plan,” February 12, 2018.

21. Nicole Kaeding, “What tax reform means for states,” U.S. News & World Report, December 18, 2017.

22. Alicia H. Munnell and Jean-Pierre Aubry, “The funding of state and local pensions, 2015–2020,” Center for State and Local Government Excellence, June 2016.

23. Holly Yan, “Here’s what teachers accomplished with their protests this year,” CNN, May 29, 2018.

24. Chelsea Dulaney and Eric Morath, “Labor force participation remains weak,” Wall Street Journal, June 1, 2018.

25. Michael McCormack, “Despite continued job growth, long-term unemployment persists,” Century Foundation, August 4, 2017.

26. Jeffrey S. Passel and D’Vera Cohn, “Size of U.S. unauthorized immigrant workforce stable after the Great Recession,” Pew Research Center, November 3, 2016.

27. Michael Frank, “Can America’s farms survive the threat of deportations?”, Atlantic, June 6, 2017; Kelsey Brugger, “Labor shortage leaves $13 million in crops to rot in fields,” Santa Barbara Independent, June 22, 2017.

28. Passel and Cohen, “Size of U.S. unauthorized immigrant workforce stable after the Great Recession.”

29. Federal Reserve Board, “Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents under their individual assessments of projected appropriate monetary policy, March 2018.”

30. Tim Lister, “Europe is on the verge of a big new crisis, just six years after the last one,” CNN, June 2, 2018; Nils Pratley, “Italy’s eurozone crisis: No easy fixes for the European Central Bank,” Guardian, May 29, 2018.

31. For example, in “The impact of work-limiting disability on labor force participation” (Health Economics 24[3], March 2015), D.A. Webber and M.J. Bjelland estimate that 4.8 million individuals have left the labor force, accounting, therefore, for more than the missing 4 million noted above. On the other hand, Monique Morrissey argues that the impact is considerably smaller (“Are disability benefits becoming more generous?”, Working Economics Blog, Economic Policy Institute, July 1, 2015).

2nd Quarter 2018

21

CONTACTS

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Dr. Daniel BachmanDeloitte ResearchDeloitte Services LPUSA+1 202 220 [email protected]

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