ByKevin L. Kliesen
Despite some crosscurrents, U.S. economic conditions remain favorable. Real gross domestic product (GDP), the broadest measure of economic activity, is poised to increase by about 3 percent in 2018, which would be its largest increase in more than a decade. More impressively, job growth has been exceptionally strong, and the unemployment rate has dropped to its lowest level in about 50 years. These tailwinds have been offset to some extent by declining activity in the housing sector and an unexpected slowdown in business fixed investment.
Although many industries have been throttled by rising cost pressures, headline inflation has moderated over the past few months and may continue to do so because of the recent collapse in crude oil prices. Despite forecasts of inflation remaining anchored near 2 percent, the latest Federal Open Market Committee (FOMC) projections suggest policymakers are likely to raise their policy rate—the federal funds rate target—three or four more times between now and the end of 2019.
After increasing at a 3.2 percent annual rate over the first half of 2018, real GDP advanced at a 3.5 percent rate in the third quarter. Although the third-quarter estimate was modestly stronger than the forecast consensus, the report nonetheless revealed some positive and negative developments. First, consumer spending has been brisk and appreciably stronger than real after-tax incomes. At some point, though, the growth of consumer spending is likely to slow to more closely match income growth. Second, government outlays continue to strengthen—both at the federal level and at the state and local level. But with the federal budget deficit projected to rise to nearly $1 trillion in fiscal year 2020, the pressure to reduce the budget deficit will likely intensify.
Other aspects of the third-quarter GDP report were more worrisome. First, real residential fixed investment—mostly new-home construction—has declined in five of the past six quarters. This development is potentially alarming because housing usually peaks before a business recession.
Second, perhaps more importantly, the growth of real business fixed investment (BFI) has slowed unexpectedly since the first quarter. The slowing in BFI growth is puzzling given strong U.S. GDP growth, healthy corporate earnings and tax incentives for firms to boost capital expenditures.
Third, exports of goods and services fell sharply in the third quarter. Slowing global growth outside the United States, trade disputes with key trading partners and a stronger value of the dollar have helped slow exports.
Finally, inventories accumulated at a rapid rate in the third quarter. This accumulation likely reflects some combination of an unexpected slowing in final sales (U.S. GDP less inventory investment), firms stocking up in anticipation of holiday sales, and increased purchases of foreign goods ahead of tariff increases. Despite these concerns, forecasters expect real GDP to increase at about a 2.5 percent rate in the fourth quarter.
Labor markets are still strong. In the year to date, nonfarm payrolls have increased by an average of 212,500 per month. This compares favorably to an average gain of about 180,000 per month over the first 10 months of 2017. The unemployment rate measured 3.7 percent in October, and the number of job openings continues to exceed the number of unemployed persons. Growth of labor productivity continues to strengthen modestly, which has helped to boost wage growth. Output per hour (labor productivity) in the nonfarm business sector increased at a 3 percent rate in the second quarter and at a 2.2 percent rate in the third quarter.
The personal consumption expenditures price index has increased by 2.2 percent over the four quarters ending in the third quarter of 2018, which is slightly above the FOMC’s inflation target of 2 percent. The question for policymakers is whether the risks for the near-term inflation outlook are skewed to the upside or downside.
Developments that could slow the growth of consumer prices over the near term include the recent plunge in crude oil prices and a rising value of the U.S. dollar (which helps lower import prices). However, there are factors that suggest the inflation risks are tilted to the upside. These include increased input costs associated with tariffs on steel, aluminum, lumber and other imported materials. Indeed, the strong economy has allowed many firms to pass along a portion of these price increases through the supply chain. Still, long-term inflation expectations remain anchored near the FOMC’s inflation target of 2 percent.
As seen in the accompanying table, the Survey of Professional Forecasters predicts that real GDP growth will slow from 3.1 percent in 2018 to 2.4 percent in 2019. The unemployment rate is forecast to average 3.6 percent in the fourth quarter of 2019, down slightly from four quarters earlier. Inflation is expected to be 2.1 percent in 2018 and 2019.
|Percent Change (Q4/Q4)||2017||2018||2019|
|Real Gross Domestic Product||2.5||3.1||2.4|
|Personal Consumption Expenditures Price Index||1.8||2.1||2.1|
|Percent (Average, Q4)|
SOURCES: Federal Reserve Bank of Philadelphia and Haver Analytics.
Rachel Harrington, a research intern at the Federal Reserve Bank of St. Louis, provided research assistance.