Inflation surprise is one of the biggest risks to economic growth for the remainder of the year, FTR senior economist Bill Witte said Thursday.
The GDP output forecast has become less optimistic over the past six months, but the labor market has exceeded expectations, FTR’s senior economist Bill Witte said Thursday.
“Most of the things that have happened over the last six months have been negative,” he said during the State of Freight webinar, referencing the government shutdown and trade relations. “Whereas we had expected growth between 3 and 4% over 2019, we’re now down around 3 or a little lower. In the labor market, by contrast, the economy has actually done a little better than we expected, although pretty close to what we expected. … We expect employment change to … average 200,000 the rest of this year and then decline.”
The consumption, business investment and housing markets were “lousy” in the first quarter, Witte said, and the contributions to the GDP growth by consumption and investment dipped significantly from 2018. The losses were offset, however, by growth in government and trade, which both showed increased growth in the first quarter compared to 2018.
The government sector’s growth will not continue as the effects of the stimulus package from late 2017 begin to wind down and the trade balance, which contributed to between 1 and 1.5% of the first-quarter GDP after being in the negative in 2018, is likely to start increasing again rather than decrease as it did in the first quarter, Witte said.
“If we’re going to have growth, we have to see recovery from Q1 in consumption, investment and/or housing,” Witte said. “My forecast in fact has all three of those things occurring.”
The model shows consumption, government and exports all surpassing 2018 growth rates, but the latter two are down for the remainder of the year compared to the first quarter, while consumption is higher. Business investment is forecast between 4 and 6%, which is down from the more than 6% experienced in 2018 but above the slightly more than 2% from the first quarter.
Housing also is forecast to grow at less than 2% for the remainder of the year after showing losses of more than 2% for both 2018 and the first quarter.
The balanced growth is forecast to result in solid output growth, he said.
Strong job growth is expected to continue through 2019 before decelerating next year. If the economy continues creating 200,000 jobs monthly through the remainder of the year as forecast, the unemployment rate could fall to about 3.5%, with some months possibly reaching 3.4%, which would be the lowest rate since the 1950s, Witte said.
The labor market participation rate appeared to be rising between 2015 and 2018, he said, but the labor force actually has declined in the last three months. The labor force generally has hovered between above 62.4% and 63.2% since 2016, which could hurt the amount of jobs created.
“If the labor force participation rate remains stable, as it really has for the last several years, in the long run the economy is only going to be able to average [100,000] to 150,000 jobs a month, which is significantly below the roughly 200,000 that we had been averaging,” Witte said. “If the decline, which is the long-run trend given the underlying demographics in the economy, sets in, again job growth of even a 100,000 will be very difficult to achieve.”
The forecast shows job growth gradually declining throughout 2020 and dipping below 100,000 in 2021.
Economic risks for the remainder of 2019 include fiscal policy programs, including the lack of hint of what will replace the stimulus package, the domestic political situation and international problems, including the trade war with China and concerns with China and Europe’s economic situations, Witte said.
The biggest risk is inflation surprise, he said. Inflation has been running low, counter to the economic theory that “when the economy gets close to capacity, and particularly when the labor market gets tight with low unemployment, that generates upward pressure on costs in the economy and those feed through into prices,” Witte explained.
“One possibility is that the theory is wrong. I am leaning more and more to that,” he said. “The second possibility is that the theory’s right and there’s just been something that’s been delaying its materialization. … If inflation does start to behave as theory says and as experience has in the past produced, then inflation becomes a problem.”
The Federal Reserve has shown in the past it would counter inflation by raising interest rates, he said.
“The experience has always been that the Federal Reserve when it counters inflation by raising interest rates overdoes it and the result is a recession,” Witte said. “That was the standard story of business cycles through most of the 20th century after World War II. I think that that’s still a possibility, but given that we don’t have any hint of the actual inflation materializing, I’m not sure how strong a possibility it is. But it’s a worrisome possibility.”
