The U. S. Economic Outlook:Upside and RisksUpside and Risks

Robert J. GordonOtta a Economics AssociationOttawa Economics AssociationOttawa, September 14, 2017Otta a, Septe be , 0

My Policy Package:“ k d ”“Be Like Canada”

• Immigration• Immigration• Medical Care• University Tuition and Debt• Parental Leave and Support – Labor Force• Parental Leave and Support – Labor Force Participation of Prime‐age Females

• My Moment in Seattle

The U. S. Economic Outlook:A Preview

• Economic Expansion Has Reached 99 Months• Economic Expansion Has Reached 99 Months– Record is 120 months, March 1991 to March 2001

l d• Current Situation:  Unemployment and Inflation

• Perspective:  What Has Killed Previous Expansions?Expansions?

• The Demand Side:  Obstacles Ahead?

Preview: Policy and the Supply SidePreview:  Policy and the Supply Side

• Monetary Policy: How Restrictive?• Monetary Policy:  How Restrictive?• Tax Cuts and Reform:  How Likely?  How Stimulative?

• Can the Supply Side Support the DemandCan the Supply Side Support the Demand Expansion?Will G th F ll B l 2%? P d ti it• Will Growth Fall Below 2%?  Productivity and the Available Supply of Labor

Length of Expansions:Current vs. Previous Five Longest

140

99

120

106

120

9992

7380

100

58

45

40

60

20

40

0

June 2009‐Sept. 2017

March 1991‐March 2001

Feb. 1961‐Dec. 1969

Nov. 1982‐July 1990

Nov. 2001‐Dec. 2007

March 1975‐Jan. 1980

Oct. 1949‐July 1953

The Current Economy:ldA Golden Moment

• “Golden” except for Harvey and Irma EstimatedGolden  except for Harvey and Irma.  Estimated hit to 2017:Q3 Growth:  3.0 to 2.3. U l t t h f ll f 10 t• Unemployment rate has fallen from 10 percent in October 2009 to 4.4 percent in August 2017

• Below Most Estimates of the NAIRU• But Inflation is Not Accelerating as in Past gExpansions

• How Low Can Unemployment Go?How Low Can Unemployment Go?– 3.8% April 2000, 3.4% Fall‐Winter 1968‐69

The Unemployment Rated hand the NAIRU, 1970‐2017

12

10

Total Unemployment

6

8

4

6

CBO Long Term NAIRU

2

NAIRU

0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Headline and Core Inflation, 1970‐2017

12

8

10

Headline Inflation

6

8

2

4Core Inflation

0

‐2

1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013

Year

A Close‐Up Look at Inflation,2007‐2017

5

4 Headline Inflation

2

3

1 Core Inflation

‐1

0

‐2

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Year

What Killed Previous Expansions?What Killed Previous Expansions?

• Most common, high interest rates as FedMost common, high interest rates as Fed responded to rising inflation– Late 1950s, late 1960s, late 1980s, ,

• Special category – oil shock inflation– In 1974 caused a recession as higher prices took away spending power

– In 1980 the Fed boosted rates to double digitsO h i l i• Other special categories:  – collapse of dot.com investment boom of late 1990s together with stock market crash1990s, together with stock market crash

– Collapse of housing and excess leverage that led up to 2008‐09 financial crisis.

Without a Negative Shock,lExpansion is a Virtuous Circle

• Employment growth causes income to grow• Employment growth causes income to grow• Income growth causes consumption spending to grow

• Higher consumption spending creates moreHigher consumption spending creates more jobs, more growth of employmentC d ’t dd l t f• Consumers don’t suddenly save most of their income, they spend it

Half of Virtuous Circle,l hEmployment Growth 1970‐2017

6

4

0

2

‐2

0

‐4

‐6

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

A Closeup of Employment hGrowth, 2007‐2017

3

1

2

‐1

0

‐3

‐2

‐5

‐4

‐6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Other Half of Virtuous Circle, Consumption Spending GrowthCircle, Consumption Spending Growth 

1970‐201710

6

8

4

6

0

2

‐2

‐4

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Personal Saving Rate, 1970‐2017

18

14

16

10

12

6

8

2

4

0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Closeup of Personal Saving Rate, 2007‐2017

10

8

9

5

6

7

3

4

5

1

2

0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Closeup of Consumption and Employment Growth Feeding EachEmployment Growth Feeding Each 

Other5

2

3

4 Real PCE

0

1

2

‐3

‐2

‐1

‐5

‐4

3

Payroll Employment

‐6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Comparison of Consumption Growthd hand GDP Growth, 2007‐17

5

3

4

Real PCEAverage of GDP and GDI

0

1

2

‐2

‐1

0

‐4

‐3

‐6

‐5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Consumption Growth 3% Since 2014,h h l ?Why GDP Growth Only 2%?

• GDP = C + I + G + NXGDP = C + I + G + NX• The sum of I + G + NX has been growing slower than GDPthan GDP

• Investment weakness, corporations sitting on d b ki fi ( h f GDP)record‐breaking profits (as share of GDP)

– Dividends, share buy‐backs

• Government spending weakness– Republican Congress forced spending cuts in 2012‐13– State and local cutbacks after recession

Comparison of Growth in Fixed Investment and GovernmentInvestment and Government 

spending, 2007‐1720

10

15Investment

‐5

0

5

‐15

‐10

5Government Spending

‐25

‐20

‐30

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Negative Net Exports,A Drag on GDP

• Net Exports Have Been Negative Since• Net Exports Have Been Negative Since 1980

• Big Widening of the Gap 1995‐2007N i f th G ft 2008 09• Narrowing of the Gap after 2008‐09 Recession

• Surprising stability in the Gap given the 2014 15 i ti f th d ll2014‐15 appreciation of the dollar

Net Exports as a Share of GDP,1970‐2017

2.0

0.0

1.0

‐2.0

‐1.0

‐4.0

‐3.0

‐6.0

‐5.0

‐7.0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Effective Exchange Ratef h llof the Dollar, 1970‐2017

130.0

120.0

100.0

110.0

90.0

100.0

80.0

70.0

1973 1978 1983 1988 1993 1998 2003 2008 2013

Year

Will Monetary Policy Choke ff h ?Off the Expansion?

• Fed’s Goal to Maximize EmploymentFed s Goal to Maximize Employment Subject to Maintaining 2% Inflation Target

• Notice inverted yield curve before each• Notice inverted yield curve before each recession

• 1974‐75, 1979‐80 Sharp Increases in Interest Rates in response to oil shocks

• 2004‐06 Another Increase of Interest rates– Beginning of housing collapseBeginning of housing collapse

• 2009‐15 Long Period of ZLB

Interest Rates:  Federal Fundsand 10‐Year Treasury Bonds, 1970‐and 10 Year Treasury Bonds, 1970

201720.0

16.0

18.0

10.0

12.0

14.0 10‐Year Government Bond Rate

6.0

8.0

10.0

2.0

4.0

0.0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Federal Funds Rate

Interest rate Closeup, 2007‐17Interest rate Closeup, 2007 176.0

5.0

3.0

4.0

10‐Year Government Bond Rate

2.0

3.0 10 Year Government Bond Rate

1.0

Federal Funds Rate0.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

The Peculiar Behavior f flof U.S. Inflation

• Given the Decline in the UnemploymentGiven the Decline in the Unemployment Rate, the Fed expected inflation to start speeding up by nowspeeding up by now

• Let’s Look Again at the NAIRU and Inflation• Long Period of High Unemployment Pushed Inflation Well Below 2%

• So far unemployment gap too small to have measureable effect on inflation

• Is 2017 decline a short‐term anomaly?

Repeat: Unemployment and NAIRURepeat:  Unemployment and NAIRU

12

10

Total Unemployment

6

8

4

6

CBO Long Term NAIRU

2

NAIRU

0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Repeat: Inflation CloseupRepeat:  Inflation Closeup5

3

4 Headline Inflation

2

3

Core Inflation

0

1

‐1

‐2

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Another Oil Price Shock?Another Oil Price Shock?160.0

120.0

140.0

80.0

100.0

40 0

60.0

80.0

20.0

40.0

0.0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Outlook forlMonetary Policy

• Strong Support for Tighter Labor Markets to• Strong Support for Tighter Labor Markets to Attract Labor Force Dropouts

• In the Absence of a Significant Upturn of Inflation, Fed will slow pace of rate increases

• Consensus forecast for mid‐2019, Federal Funds rate of 2 7 to 3 0Funds rate of 2.7 to 3.0

• Implications for 10‐year bond, yield curve• Fed will begin to run down balance sheet

Setting the Stage for Fiscal Drama:h f d bThe Deficit and Debt

• Federal Deficit / GDPFederal Deficit / GDP–Big bulge from recession, Obama stimulus–Recent increase

• Federal Debt / GDP/–Big increase from recession, Obama stimulusstimulus

–Slow projected increase from now even with current tax rateswith current tax rates

–Big tax cuts will raise deficit, debt

Federal Deficit / GDPSince 1970

4

0

2

‐2

0

‐6

‐4

‐8

‐10

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025

Year

Closeup of Federal Deficit / GDPSince 2007

2

0

‐4

‐2

‐6

4

‐8

‐10

2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

Year

Federal Debt / GDPSince 2007 Out to 2027

100

80

90

50

60

70

30

40

50

10

20

0

2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

Year

The Great Washington Dramad fStarting Now:  Tax Cuts and Reform

• Corporate Tax Cuts from Current 35%• Corporate Tax Cuts from Current 35%–Trump’s Campaign Promised 15%–Congress Will Go for 20 to 25%

• How to Pay?• How to Pay?– Initial Idea, Border‐Adjusted Cash Flow Tax–Similar to a Value‐Added Tax with a Wage Bill DeductionBill Deduction

–Raises Revenue Because Imports > Exports

Corporate Tax ReformCorporate Tax Reform

• Border‐adjustment idea is dead• Border‐adjustment idea is dead– Predicated on an appreciation of dollar– Political opponents didn’t believe in dollar change

– This source of revenue won’t happen

• Other changesg–Move to territorial tax system like other countriesFull expensing end interest deduction– Full expensing, end interest deduction

• Revenue Cost 0.6% of GDP

Personal Tax ReformPersonal Tax Reform

• Move to Fewer and Lower Rates• Not as Much of a Windfall to the Rich as the 2001 Bush Tax Cuts

• Possible reform:  End deduction for state/local taxes (high tax states voted for Hillary Clinton)

d i i h i bl• Deductions to remain:  charitable contributions, mortgage interest, employer health plansplans

• Strong opposition to raising deficits, but a deficit‐neutral policy will not stimulate economyp y y

• How much will they dodge the deficit issue by optimistic growth forecasts?

Is There Enough Supply tod h?Meet Faster Demand Growth?

• 2 1 percent GDP growth since 2009 Mad• 2.1 percent GDP growth since 2009 Mad Possible by a Decline in U Rate from 10 to 4.4

h ll d l• At some point the U Rate will stop declining• How Fast Can the Economy Growth With a yConstant Unemployment Rate?

• Actual Growth Rate 2006 2016 = 1 3%• Actual Growth Rate 2006‐2016 = 1.3%– Productivity Growth 0.9%–Hours Growth 0.4%

GDP Growth at a ConstantlUnemployment Rate

5

4

4.5

2.5

3

3.5

1.5

2

2.5

0.5

1

0

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Productivity Growth at a ConstantlUnemployment Rate

3.5

2 5

3

2

2.5

1

1.5

0.5

0

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Hours Growth at a ConstantlUnemployment Rate

2.5

2

1.5

1

0.5

0

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Two Questions:  Productivityd hand Hours Growth

• Productivity growth 0.6 percent for seven yearsProductivity growth 0.6 percent for seven years since mid‐2010

• Forecast for next 25 years in my book is 1.2Forecast for next 25 years in my book is 1.2 percent

• Big question: as labor markets tighten, will firmsBig question:  as labor markets tighten, will firms buy robots and other capital to replace workers?

• Evidence that trend productivity growth is fasterEvidence that trend productivity growth is faster when unemployment is low as in the 1960s and 1990s

• Possibility for next three years, 1.0 percent

For GDP to Grow at 3%,d h fWe Need Hours Growth of 2%

• Past Year:Past Year:– Population +0.6%– Labor Force +0.8%Labor Force +0.8%– Hours +1.3%

• HowMuch Lower Can Unemployment Go?How Much Lower Can Unemployment Go?• Evidence of Tightness in Labor Market• Sources of Additional Labor Supply• Sources of Additional Labor Supply

– Prime‐Age Labor Force ParticipationEmployees Working Part time Who Want Full time– Employees Working Part‐time Who Want Full‐time Work

New Claims for Unemployment llInsurance – An All‐time Low

0.4

0.3

0.35

0.25

0.15

0.2

0.05

0.1

0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016Year

Job Openings, Layoffs, HiresJob Openings, Layoffs, Hires7000

5000

6000Hires

4000

5000

2000

3000 Job Openings

1000 Layoffs

0

2001 2003 2005 2007 2009 2011 2013 2015 2017

Year

Prime‐Age Participation RatePrime Age Participation Rate90

85

75

80

70

75

65

60

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Year

Female Participation Rates,dUS vs. Canada, 1976‐2016

70

65 US LFPR

60

50

55 Canadian LFPR

45

40

1976 1981 1986 1991 1996 2001 2006 2011 2016

Part‐time Workers Wholl kWant Full‐time Work

7

5

6

4

5

2

3

1

0

1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016

Year

ConclusionConclusion

• Consensus GDP Forecast for 2018 and 2019:  2.3– Productivity 1.0– Labor Force 0.8%– Hours 1.3%

• Hours Growth Made Possible by Declining U l t L b F R t d ShiftUnemployment, Labor Force Re‐entry, and Shift from Part‐time to Full‐time Work

• Sources of Uncertainty• Sources of Uncertainty– How Much Will Tax Cuts Add to Deficit?– HowMuch Will Monetary Policy Fight Against FiscalHow Much Will Monetary Policy Fight Against Fiscal Stimulus?