1

The Outlook for the U.S. Economy

Anthony Murphy Federal Reserve Bank of Dallas

(anthony.murphy@dal.frb.org)

Vistas from Texas Conference Dallas, 4 Nov 2016

The views expressed are those of the author, and are not those of the Federal Reserve Bank of Dallas or of the Federal Reserve System.

2

Modest Economic Growth since Great Recession Real GDP Growth in 2016 - 0.8% Q1, 1.4% Q2 and 2.9% Q3

2011 2012 2013 2014 2015 2016 YTD

GDP Growth, % SAAR 1.6 2.2 1.7 2.4 2.6 1.7

Contributions to Growth, PPAR

- Personal Consumer Expenditure 1.6 1.0 1.0 2.0 2.2 1.8

- Non-Residential Fixed Investment 0.9 1.0 0.4 0.8 0.3 -0.1

- Residential Fixed Investment 0.0 0.3 0.3 0.1 0.4 -0.1

- Inventories -0.1 0.1 0.2 0.1 0.2 -0.3

- Net Exports 0.0 0.1 0.3 -0.2 -0.7 0.3

- Government -0.6 -0.4 -0.6 -0.1 -0.3 0.0

Note: PPAR = percentage points at annual rates, SAAR = seasonally adjusted at annual rates. Source: BEA.

3

Many External and Internal Shocks Including Low Oil Prices

Mining v. Other Non-Residential Investment

40

60

80

100

120

140

160

180

800

1,200

1,600

2,000

2,400

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Structures, Equipment & IP

Structures & Equipment

Mining SectorStruct & Equip

Non-Mining Sectors Struct & Equip

SAAR, $2009B SAAR, $2009B

Sources: BEA and author’s calculations. Note: NBER dated recessions are shaded grey.

4

Deleveraging Important Reason Why Recovery from Great Recession So Slow

Household Deleveraging Probably Complete

70

80

90

100

110

120

130

140

150

500

520

540

560

580

600

620

640

660

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

H'hold Debt / Income

Percent

H'hold Net Worth / Income

Sources: BEA and Federal Reserve,

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Unemployment Rate Close to NAIRU or Natural Rate U6 Includes “Part Time for Economic Reasons” & Discouraged Workers

2

4

6

8

10

12

14

16

18

96 98 00 02 04 06 08 10 12 14 16

Percent, SA

CBO "NAIRU" or Natural Rate

4.9%

"Broad" U6Unemployment Rate

Oct '16

9.5%

"Headline" U3Unemployment Rate

Source: BLS and CBO.

6

Labor Force Participation Rate Has Ticked Up Especially Prime Aged (25–54 Years Old)

58

60

62

64

66

68

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Percent, SA

Labor ForceParticipation Rate

62.8%

59.6%

Oct '16

Employment toPopulation Rate

Source: BLS.

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Robust Employment Growth, Resilient to Shocks

-1,000

-800

-600

-400

-200

0

200

400

600

2000 2002 2004 2006 2008 2010 2012 2014 2016

Monthly Change3 Month Moving Average

SA 000's, M/MChange in Non-Farm Payrolls

+161Oct '16

Source: BLS

Year 2011 2012 2013 2014 2015 2016 YTD Monthly Ave (000’s) 174 179 193 251 229 181

8

Wage Inflation Slowly Picking Up Need to Look at a Range of Wage Measures

0

1

2

3

4

5

6

2000 2002 2004 2006 2008 2010 2012 2014 2016Average Hourly Earnings, Priv Prodn & Non-Super (M)Employer Cost Index, Private Wages & Salaries (Q)Atlanta Fed Wage Tracker, Smoothed Median (M)

Percent, Y/Y

3.6% Sep '16

2.4% Oct '16

2.4% Q3 '16

Note: Average hourly earnings for all workers: +2.8% Oct 2016. Source: BLS and Atlanta Fed.

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Forecasts of Output and Unemployment Moderate Output Growth and Unemployment below NAIRU

2016

Q4 2016

Q4/Q4 2017

Q4/Q4 2018

Q4/Q4 2019

Q4/Q4 Real GDP Growth Blue Chip (10 Oct) 2.4 1.5 2.2 - - FOMC (21 Sep) - 1.8 2.0 2.0 1.8 SPF (12 Aug) 2.2 1.5 2.2 e 2.2e 2.2e

2016 Q4

2017 Q4

2018 Q4

2019 Q4

Unemployment Rate Blue Chip 4.7 4.6 - - FOMC 4.8 4.6 4.5 4.6 SPF 4.7 4.6 e 4.6 e 4.7 e

Sources: Blue Chip Economic Indicators (10 Oct 2016), Survey of Professional Forecasters (SPF, 12 Aug 2016), and Federal Open Markets Committee (FOMC, 21 Sep 2016, Summary of Economic Projections median).

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Underlying Inflation Edging Towards 2% Target Inflation Expectations Reasonably Well Anchored

-2

-1

0

1

2

3

4

5

2000 2002 2004 2006 2008 2010 2012 2014 2016

Headline (All Items)Core (Ex. Food & Energy)Trimmed Mean

Percent12 Month PCE Inflation

2% Target

Sources: BEA and Dallas Fed.

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Forecasts of Inflation Reverting to 2% Target

2016

Q4 2016

Q4/Q4 2017

Q4/Q4 2018

Q4/Q4 2019

Q4/Q4 CPI Inflation Blue Chip (10 Oct) 2.4 1.2 2.3 - - SPF (12 Aug) 2.2 1.6 2.3 2.3 - PCE Inflation FOMC (21 Sep) - 1.3 1.9 2.0 2.0 SPF 1.9 1.4 1.9 2.0 - Core PCE Inflation FOMC - 1.7 1.8 2.0 2.0 SPF 1.6 1.8 1.9 2.0 -

Sources: Blue Chip Economic Indicators (10 Oct 2016), Survey of Professional Forecasters (SPF, 12 Aug 2016), and Federal Open markets Committee Summary of Economic Projections (FOMC, 21 Sep 2016, median).

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Monetary Policy

• Fed has dual mandate – maximum employment and price stability • Wednesday’s FOMC statement:

o The labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year

o [FOMC] expects that … economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further

o Inflation is expected to rise to 2 percent over the medium term o Near term risks to the economic outlook appear roughly balanced

• Interest rates: o “The Committee judges that the case for an increase in the federal funds

rate has continued to strengthened but decided, for the time being, to wait for some further evidence of continued progress towards its objectives” (Changes in statement wording underlined)

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Longer Term Economic Challenge: Low Growth Estimates of Long-Run Growth Revised Down

Year Blue Chip SPF CBO FOMC

2000 3.1% 3.0% 2.9% -

2005 3.2% 3.3% 2.6% -

2010 2.6% 2.6% 2.2% 2.7%

2012 2.5% 2.5% 2.3% 2.5%

2014 2.4% 2.6% 2.1% 2.3%

2016 2.1% 2.3% 1.9% 1.8%

Sources: Blue Chip Economic Indicators, Survey of Professional Forecasters (SPF), Congressional Budget Office (CBO) and Federal Open Markets Committee (FOMC) Summary of Economic Projections (median).

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Low Productivity Growth

• Low growth due to an aging population and lower labor productivity

• Labor productivity growth is the most important determinant of the long run growth in wages and living standards

• Key component of labor productivity growth is total factor productivity (TFP) growth – the growth in the efficiency with inputs such as capital and labor are combined to produce output, e.g. o Improvements in technology, producing higher value

products and services, better organization of production • Limited role for monetary policy or short-term fiscal policy

(demand side policies) in tackling low productivity growth • Supply side policies needed

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US Labor Productivity Growth Slowed in Early 1970’s with Temporary Surge from 1995 to 2004

Source: BLS and Baily and Montalbano (2016).

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Tackling Low Productivity Growth

• At the micro level, low TFP reflected in: o Widening gaps between frontier and other firms o Fewer start-ups and less “creative destruction” reallocation of

production among firms • Research suggests that declining business dynamism is the

main factor • Boost diffusion of new technologies and best practices by:

o Increasing competitive intensity Simplifying and rationalizing economic regulation Limit patents – too little competition, too much rent seeking Reduce licensing restrictions – barrier to entry More competition in health care

o Improving managerial and worker skills • Other policies – infrastructure investment , tax and immigration

reform, more Federal support for R&D – would also help

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Decline in U.S. Firm Startup Rates

Source: Decker et al (2016)

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Summary

• Economic outlook is for: o Moderate (2% to 2¼%) growth for the next few years o A stronger labor market o Low (2% or lower) inflation o Gradual rise in interest rates

• Outlook better than in most advanced economies x • The near term risks to the outlook are fairly balanced

o The downside risks are predominantly external o Sluggish global growth, recession in China, hard Brexit,

failure of Deutsche Bank etc. • In the longer term, supply side policies are needed to

tackle low productivity growth