The fundamental question for the U.S. macroeconomic forecast is if the pandemic recovery can continue or if the economy is heading into a recession. This outcome will be determined largely by Federal Reserve actions during the quarters ahead. Given how long the Fed waited to fight the current bought of inflation, it is not likely they can return inflation to its target rate without monetary policy changes which would also induce a recession.

It is an open question if the Fed has the fortitude to follow-through fighting inflation. The forecast then, is either for recession, or anemic growth accompanied by continued inflation.

CERF’s baseline forecast embodies the assumption that the Fed will cease substantive hikes by December 31^st of 2022 and that the economy will not be pushed into recession. We do have one 25 basis point hike in early 2023, but no other hikes. This is a low confidence forecast, since it necessarily involves predicting the behavior of a body of political actors at the Fed.

This forecast for the Fed’s policy rate has implications for inflation. Inflation, with substantial momentum at the current time of writing, will not be much reined in by this forecast of Fed policy.

How strong is the Fed’s policy stance on inflation? The real ten-year Treasury yield was -3.1 percent using September yields with the core PCE deflator. As conventional wisdom has always argued, a negative interest rate of that magnitude indicates policy that is massively stimulative.

The presumed level of short term interest rates under this forecast scenario is that they reach 4.625 percent (based on the midpoint of the Fed’s target range) by mid-2023. By the Fed’s own analysis the rate needs to be above 6 percent in order to adequately combat inflation.

Inflation will subside, but it will not subside quickly, and the real 10-year Treasury yield will remain in negative territory for all of 2023, indicating that instead of being restrictive, the Fed’s policy will remain stimulative, for about a year.

We forecast that the Core PCE deflator will still be 4.8 percent at the end of 2022, and that it will still be 4.3 percent at the end of 2023. This is higher than the consensus forecast of 3.2 percent, but our forecast is lower than inflation expectations, such as the University of Michigan’s survey value of 4.8 percent.

This forecast is one where rates are not really that high. The chart below shows the third quarter real 10-year Treasury is still quite negative, and it shows real rates during the Volcker policy era in the early 1980s that did succeed in fighting inflation, and also pushed the economy into recession.

Because rates are not really that high, inflation will remain persistent, and, growth will be weak but positive. We do not forecast a recession in this scenario, in part because rates are not actually that high. They will not get high enough to halt inflation, and they will not be high enough to cause a recession.

CERF has argued that monetary and fiscal policy has been much too stimulative. While it is possible to justify stimulating the economy in the time of crises, policies have been a ratchet, ramping up support through payments and credit in times of crises and not subsiding thereafter. This occurred after the 2007-08 financial crises and again during the Pandemic in 2020.

Overly-stimulative policies help us understand the macroeconomic environment we are in today. Some forecasters are saying that the Fed’s impotence against inflation, with 300 basis points of hikes in seven months having failed to slow inflation momentum, has surprised almost everyone. This does not surprise CERF. The economy is overstimulated. According to CoBank estimates the U.S. household sector still has $2 Trillion in excess savings. And, we point to the most recent University of Michigan survey data, which as of October showed consumer’s expect inflation will still be 4.8 percent a year from now.

There are risks to this forecast. One alternate scenario is that the Fed does continue raising rates aggressively during 2023, sending the short term policy target well-over 6 percent. In this scenario, the real 10-year Treasury yield would surge into positive territory more rapidly, inflation would subside more quickly during 2023, and the economy would experience a recession.

Why is our baseline case that the Fed does not get in front of inflation? They have shown before that they are sensitive to markets, especially, the stock market. In October of 2018, they announced a balance sheet normalization policy that sent the S&P 500 into a 24 percent decline in just 3 months. On January 4, 2019, Fed chair Jerome Powell signaled a reversal of policy normalization, and in March of that year, stated that a multi-trillion dollar balance sheet might go on indefinitely. This of course, gave rise to the notion of QE-infinity, the idea that the Fed would never normalize policy.

The effect of significantly higher rates will have an important follow-on effect of raising the debt service costs for the U.S. This is more of an issue now, where the debt to GDP ratio is 120 percent, a historically high level for the U.S. This will be another source of pressure against further Fed rate hikes to levels above 5 percent.

CERF’s economic forecast for the next eight quarters is for growth substantially below potential. Many forecasters, including the Fed, point to demographic factors and make post-industrialized economy arguments to rationalize below potential growth. CERF disagrees. Most of the sub-par growth is driven by poor policies, policies that throw a blanket on what would be a much more healthy and robust economy.

Monetary and fiscal policies should follow policy rules, or a logic that is guided by economic theory and analysis. Policies since 2008, especially monetary policy, have been ad hoc. They depress economic activity through the specific disincentivizing impacts they impart on investing for the future, but in addition, they depress the economy through policy uncertainty. This uncertainty doesn’t just add difficulty to forecasting, but it also reduces the ability of households, establishments, and governments to make decisions for their, and the our nation’s, future.

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The BLS April Employment Situation is now available for all to see.  After economic forecast houses across the globe ran their models beginning in mid-March and re-ran them again and again until as recently as last night, we now have bona fide economic data on the historical and life changing event that we are living through.

Before even jumping in to the details of the report, we want to use this space to urge Governors to implement careful but sensible plans for re-opening their economies immediately. Just as importantly, we urge them to communicate the timeline for re-opening, even if plans are tentative. Simply stating that, “We will be guided by science.” is not a plan. And, waiting for cover from public health officials will significantly lengthen the country’s economic crisis and the overwhelming social costs that result.

CERF’s forecast for April was for employment losses of 19.7 million and an essentially flat labor force. The data shows employment losses of 22.4 million and an almost 6.5 million drop in labor force. While the employment loss was reasonably close to our forecast, the labor force contraction was not. In retrospect, we underestimated the massive disincentive to working (or even looking for work) that the CARES Act brought to the labor market. The April unemployment rate is 14.7 percent, lower than our forecasted rate of 16.5 percent. Our forecast error in this case is driven almost entirely by our miss on the contraction of labor force. If labor force had held at February’s level, the April unemployment rate would have been 18.9 percent.

The jobs breakdown by sector shows that the hardest hit of the major sectors were Leisure & Hospitality, Education & Healthcare Services, Professional & Business Services, and Retail Services. With job losses of 7.7, 2.5, 2.1, and 2.1, respectively, all experienced losses numbering in millions of people. Across the spectrum of industries, as well as across sub-segments within these industries, lower-paid workers were hit hardest. These workers and the households they reside in will suffer, as they are the least able to weather an adverse economic shock such as this.

The report has a number of black linings, not silver linings as some analysts have reported. First, the employment losses reported today almost completely wipe out all of the gains accumulated since the Great Recession. The labor force contractions are especially worrisome. Labor force contractions reduce the productive capacity of our nation. They put people on the couch, which leads to many kinds of well-documented social costs, including increased rates of domestic violence, divorce, and even suicide. What’s more, while 88 percent of survey respondents indicated that their job loss was temporary, this is not likely to prove true. We are persuaded by a University of Chicago study that suggests half of these self-proclaimed temporary losses will become permanent.

This morning’s report also provides evidence that the shutdown is eroding the core of the U.S. economy. Consider the position of American Latinos. As we document in the 2019 LDC U.S. Latino GDP Report, Latinos are a tremendous source of economic growth for the nation. In fact, despite being only 17 percent of the population, Latinos are responsible for more than 80 percent of the growth of the labor force from the Financial Crisis up to the start of the pandemic. The April report indicates that Latino employment dropped by about 6 million persons, a nearly 24 percent share of the nation’s job losses. Because Latinos were more likely to be working, they were also be more likely to be furloughed or laid off during the downturn. The problem for the nation is that the labor force’s strongest growth cohort is being disproportionately harmed. The core of the American economy is eroding, and this diminishes the long-term growth outlook for the nation.

The dramatic concentration of impacts in a few job sectors and among specific demographic groups indicates that the shutdown is also increasing inequality across every state in the nation.  Consider the contrast between a technology professional who shops at Nordstrom’s and an employee of the store. The government-mandated closure of a Nordstrom’s store has minimal impact on the technology professional, who will simply move her shopping online as she conducts her own employment responsibilities from home. The tech professional’s inconvenience will largely end with the closure order. In contrast, the Nordstrom’s employee will experience both lost income and lost work experience. The effects will be enduring. The Nordstrom’s employee confronts a much-changed economic reality.

The policy responses to the spread of the coronavirus have already initiated a historic economic contraction. These economic convulsions necessitate an immediate response. Lifting shelter-in place orders for all but the most vulnerable groups is essential. Research from the NBER indicates that narrowly targeted lockdowns along with continued social distancing practices and robust testing can minimize both loss of life and the extraordinary economic losses detailed in this morning’s report.

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There are no surprises in our California forecast.  There aren’t any changes either.  We expect California to continue plugging along as it has for several years now.  The growth on average will be slow, but the Bay Area will do better.

We don’t see much upside potential.  That is, we would be very surprised if California’s economy did a lot better than the forecast.

We see plenty of downside potential.  New regulations and taxes will have a negative impact, but we would not expect to see an immediate or dramatic drop.  Instead, we’d expect to see California’s economy slowly lose vigor.

A national or global financial—it’s possible, leverage is high and banks are stressed worldwide, particularly in Europe—crisis would have more direct impact.  The immediate impact would be a large fiscal deficit at the state level.  The State’s response would likely be as always.  Taxes would go up.  Transfers to local governments would go down.  Debt would go up.

California’s financial situation has improved during Brown’s two terms, but California has not made the fundamental changes necessary to increase the budget’s resiliency.

Making California’s budget less susceptible to business cycles would require a major tax restructuring, reducing the reliance on a wealthy few while broadening the tax base.  It would also require that the State’s pension obligations be brought under control.

Is Sacramento likely to make the changes necessary to strengthen California’s budget?  Probably not, but now seems like an excellent time to do so.

A one-party state provides opportunity.  While the required changes would help most Californian’s, some groups would be hurt.  Those groups are part of the ruling party’s coalition, government employees and those who despise the existence of wealthy people.  The opportunity comes from the fact that these people have no place else to go.  They will not vote Republican.  The worst they could do to Democrats is sit out the election, but the party could easily retain power if that happened.

California’s Democrat Party now dominates California’s politics to such an extent that it has a unique opportunity to confront California’s long-standing issue without paying a political price.  It’s a perfect time for Governor Brown to cement a legacy.

The post California Forecast appeared first on Center for Economic Research and Forecasting.

It’s time for another presidential election.  Each candidate is promising new initiatives that will bring prosperity to Americans.  So, we’re forecasting vigorous economic growth?  No.

Our forecast is pretty much the same as it’s been for years, anemic economic growth as far as we can see.

Either Trump or Clinton will be president, but which one is president doesn’t matter for our forecast, because neither has a program that will generate the promised growth.

Trump’s economic plan is as brash, contradictory, and dishonest as he is.  He begins by assuming that countries compete economically.  This is a long-standing and popular misconception.  While not fans of Paul Krugman, we refer readers to his book Pop Internationalism for a readable, but sarcastic and arrogant, discussion of why this is not true.

Trump does offer tax, energy, and regulatory reform, which would increase our economy’s growth rate.  Those gains would be offset by his trade policies and his intention to export immigrants.  Decreasing trade and exporting workers, regardless of how the workers got here, are extraordinarily contractionary policies.  The plan is dishonest because he presents it as a unified pro-growth plan when he has advisors who have surely told him of the contradictions.

Clinton’s plan is as old, tired, and dishonest as she is.  It’s tax.  It’s spend.  It’s free stuff.  It’s more government.  It’s the same thing we’ve seen out of the Washington establishment for decades.  We all know, and she must know, it won’t bring the growth she promises.

We believe that presidents can have an impact on economic growth.  However, the president must be extraordinary and have congressional support, either because of party loyalty or political pressure.

President’s Kennedy, Reagan, and Clinton each initiated strong recoveries, recoveries that lasted for many years and saw several years of 4.0 percent or greater economic growth:

There were similarities between each of these presidents’ dominant economic policies.  Each relied on incentives and generally free-market solutions.  Kennedy cut taxes.  Reagan cut taxes and the regulatory burden.  Clinton expanded trade and changed welfare’s incentive structure.

We could have a similarly vigorous economy today, but the challenges are daunting.  It would require eliminating the negative incentives in three major pieces of legislation: Sarbanes-Oxley, The Affordable Healthcare Act, and Dodd-Frank.  It would also require rolling back the bureaucratic albatross that has built itself, increment by increment, into a formidable obstacle to economic growth.

Taxes should be reformed.  Eliminating taxes on repatriation of foreign earnings and on dividend income would be expansionary.

Monetary policy may be the biggest challenge to any president’s plan for a sustained vigorous economy.  It’s hard to see how the distortions built up by years of near-zero interest rates can be corrected without a dramatic decline in asset prices, a decline that would likely precipitate at least a short recession.  In a sense, the Fed has painted itself into a corner.

Whatever the Fed’s challenges, they are supposed to be independent of the other branches of government.  Presumably, the President’s only input is the nomination of the Chair and other board members.  We don’t believe the Fed is as independent of the political pressure as is advertised.  That said, it would take a very special Fed Chair to correct the current distortions.

Volker famously conquered inflation through a bold and controversial monetary policy, at the cost of what was until then our deepest recession.  The president would need to nominate and have confirmed another Volker.  We have no idea who that might be.

The four percent economic growth that Trump promises is possible, but it would require an extraordinary president to achieve it.  Unfortunately, our nomination process appears incapable of nominating extraordinary people.

The post United States Forecast appeared first on Center for Economic Research and Forecasting.

The Federal Reserve Board on Monday approved a final rule requiring the largest, most systemically important U.S. bank holding companies to further strengthen their capital positions. Under the rule, a firm that is identified as a global systemically important bank holding company, or GSIB, will have to hold additional capital to increase its resiliency in light of the greater threat it poses to the financial stability of the United States.

John Cochrane is happy to see this, as am I.  However, he sees the biggest benefit as increased bank capital, and he seems to be arguing that there is no cost to firms for this.  I think there are higher costs to the GSIBs, and I don’t think increased capital at banks is the major benefit of the regulation.

Remember, this regulation doesn’t apply to all banks, only ones identified as Global Systemically Important Banks (GSIB).

If GSIBs compete with non-GSIBs, they will have lower return on equity than non-GSIB for similar investments, a result of the math of leverage.  That means they will have to pay more for capital.

Instead of increasing bank capital, it seems to me the FED is trying to get rid of Too Big To Fail (TBTF) banks.  The increased capital works like a tax on GSIBs.  They will have an incentive to break themselves up, creating more and smaller banks.

This is all good.  The banking industry has been increasingly dominated by a very small number of very large banks.  A larger number of smaller banks will increase competition and innovation.

There will be other impacts.  My colleague Jeff Speaks points out that in addition to providing a competitive advantage for smaller banks, a desirable outcome, financial stability should be increased by reducing the probability of large bank failures.

Jeff adds that there may be a negative impact if GSIB respond to lower return on equity by increasing the riskiness of their investments.  I suspect the FED believes its regulators can prevent this from happening.

This regulation came out the day before the fifth anniversary of Dodd-Frank.  I wonder if the timing was deliberate.  Dodd-Frank is a failed regulation that was, among other things, supposed to solve the problem of Too Big To Fail.  Is the FED sending a message to Congress?

The post Good News from the FED appeared first on Center for Economic Research and Forecasting.

Consumption expenditures grew at 2.2 percent in quarter four, compared with 1.6 percent in quarter three. Fixed investment grew 9.7 percent, compared with 0.9 percent in quarter three.

I put a table with relevant data here:

Forecasting GDP is hard enough, but the volatility makes the task even harder. The drivers of the volatility in recent quarters have been inventory investment and government, where the contribution to GDP growth each has changed sign twice in the last two quarters.

I do not actually try to forecast the volatility in GDP, our GDP growth forecast is purposely “smoother” than recent history. This makes our forecast easier to explain to our clients, and reduces the risk of a large forecast error, particularly the error of getting the sign wrong. This strategy did not help this time, as our forecast was 1.5 percent for fourth quarter.

What we try to do with our forecasts is to be closer to the truth than our competition. Our competition is the Wall Street Journal consensus of forecasters, a survey of 50 of the top forecasters from around the country. The consensus forecast was 1.6 percent. We were slightly closer to the reported truth than consensus.

The partner to the numerical calculation of the forecast is the story we tell our clients. From this point of view, we have been more accurate than our competitors. We have cautioned our clients about underlying weakness in the economy for many years now, in fact, ever since the fall of Lehman Brothers in September 2008. The new quarter four data provide evidence that weakness still exists.

Residential investment has been strong now for five quarters in a row, and home prices are indicating a gradual housing market comeback. This is good, but the housing comeback will take time and it might never reach pre-recession highs. This probably means some of those construction workers will never again work in that field.

Our January 10 forecast for 2013 quarter one was 1.2 percent, weaker than our forecast for quarter four of last year. With the new quarter four data, I will rerun the model, and while the negative contribution to GDP from government expenditure will likely need to be viewed as a one-time hit, the slowdown in inventory investment and export growth will likely be viewed as indication of weaknesses that will continue to exist in the this quarter.

The post GDP, GDP Volatility, and the Forecast appeared first on Center for Economic Research and Forecasting.

The unemployment rate fell from 7.9 percent in October to 7.7 percent in November which might appear to be good news. However, this change was driven mostly by a contraction in the labor force of 350 thousand persons. So this is more a function of discouraged job-seekers leaving the labor force than any other factor.

Job growth was 146 thousand jobs, essentially the same as our forecast of 145 thousand jobs. The September jobs number was revised, from a gain of 148 thousand jobs down to a gain of 132 thousand jobs. The October number was also revised, from a gain of 171 thousand jobs down to a gain of 138 thousand jobs. These revisions accumulate to almost 50 thousand jobs less than what was previously thought.

On December 12, the United States Federal Reserve Open Market Committee announced a monetary policy that plans to keep the federal funds rate low until the unemployment rate falls to 6.5 percent.

Curious about how long it would take to get to an unemployment rate of 6.5 percent at current job growth rates, I did a simple calculation. I used the 146 thousand payroll survey jobs to drive a proportionate change in the household survey employment level, which ends up being monthly employment increases of 156 thousand persons. I set civilian labor force on a gradual growth path that maintained the current labor force participation rate at 63.6 percent. These assumptions imply that the United States unemployment rate would subside to 6.5 percent by June of 2017.

June of 2017 is a long way off. I hope job growth will exceed 146 thousand in months to come.

The post Jobs and the 6.5 Percent Unemployment Rate appeared first on Center for Economic Research and Forecasting.

Bloomberg’s consensus jobs estimate was 100,000. Our forecasts for jobs and economic growth have been consistently under consensus since September 2008. Thus far, our forecasts continue to be vindicated by the data. We would prefer to become optimistic, but have not yet found the opportunity to do so.

Key headwinds for future job growth include Euro area instability, US Macroeconomic policy uncertainty, slow Asia growth, and a still-weak real estate market in the United States.

We remind our clients that real estate is still a key negative factor in the U.S. economy. Household sector wealth remains weakened by falling Case-Shiller home prices, and the weak job market mixes with the large distressed inventory to keep the prospects for a near-term uptick in housing values dim.

The post The June 2012 Jobs Report appeared first on Center for Economic Research and Forecasting.

Consumption Expenditures                       2.04
Investment Expenditures                           0.77
          Fixed Investment                             0.18
          Inventory                                          0.59
Government Expenditures                       -0.60
Net Exports                                              -0.01

First quarter growth was mostly growth in household consumption expenditures. The other components, as can be seen above, did not contribute very much. The investment expenditures contribution was mostly due to a positive inventory adjustment. Fixed investment expenditure growth, the expenditures that contribute to future productive capacity, was quite low in quarter 1 at 1.4 percent.

The composition of growth in fixed investment expenditure components was:

Fixed Investment Expenditures                 1.4
          Business Structures                      -12.0
          Equipment/Software                        1.7
          Residential Structures                   19.1

Fixed investment growth contained dramatically offsetting factors, with business structures contracting massively, residential structures expanding massively, and equipment/software growing slowly. While this national income and product account dataset is not available by state, it is close to guaranteed that the large expansion in residential structures is not on the coasts of the United States. It will be occurring in the middle of the country, from North Dakota down to Texas. The heterogeneity of growth across U.S. states has been a noticeable characteristic for a couple of years now, but that should be the topic of another blog.

The first quarter GDP result was broadly in-line with our forecast. Economic activity slowed down from 3 percent in 2011 quarter 4 to 2.2 percent in 2012 quarter 1. Our forecast called for more of a slowdown, to 1.5 percent. The largest reasons our forecast was slower than the actual were: consumption and inventory investment. Our forecast of 2.0 percent for consumption was only about 2/3rds of the actual value of 2.9 percent, and our forecast of about $40 billion dollars for inventory investment was $30 billion too low.

Again, I will use this blog-space to complain about the personal savings rate. It has been falling for six quarters in a row now, and this worries me. At 3.9 percent, it is at the lowest level since 2007 quarter 4. Given the still-too-high household debt levels in the United States, a rising savings rate would be more consistent with robust future economic growth.

The post The Advance Estimate of Quarter 1 GDP appeared first on Center for Economic Research and Forecasting.

The estimate is higher than my forecast by a fair amount actually, but in the grand scheme of forecasting, forecast errors, and the direction of change, I am reasonably happy. I had forecasted the increase in growth with trepidation because the economic fundamentals remain weak.

The fourth quarter data implies that the economy grew 1.7 percent in 2011, compared with 3.0 percent in 2010.

What were the drivers of the increase in fourth quarter growth? Consumption and Investment expenditures both rose, $50b and $80b respectively, trade was little changed, and government expenditures fell about $30b.

Investment expenditures are driven by a four main components, business structures, equipment and software, residential, and inventory investment. All of these components are volatile, but one of them, inventory expenditures, is super volatile. Sure enough, about $55b of the $80b investment expenditure increase was due to inventory investment. I hope that the shelf-stocking was not overdone for if it was, there would be a slowdown in inventory investment this quarter.

Another interesting movement within Investment was residential, up at an annualized growth rate of about 11 percent. While residential investment in states like Nevada, California, Florida remain at historic lows, it is booming in states like North Dakota, Oklahoma, and Texas. We can thank the middle part of the country for this source of growth.

The $30b pullback in government expenditure breaks down to a $20b decline in Federal and a $10b decline in State/local expenditures. The Federal change was due to a defense spending contraction, as non-defense expenditures rose slightly.

Inflation, as measured by the GDP deflator, fell dramatically from 2.6 percent in third quarter to 0.4 percent in fourth quarter. Subdued inflation in a time of relatively high unemployment is a good thing, as it helps those unemployment or partially-unemployed households manage expenses.

The BEA measure of the personal savings rate fell from 3.9 percent in third quarter to 3.7 percent in fourth quarter. This worries me, as household debt levels are still high. I have argued this before and will do it again: consumption in an era of high household debt does not help the economy. What is needed is savings and investment. Future growth depends on it.

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