In part thanks to the tax reform bill signed in December, the United States economy may progress quicker than previously expected, even though forecasts attempted to factor in the then-hypothetical tax bill ahead of time, according to the Economic Advisory Committee of the American Bankers Association. A strong close to 2017 influenced forward-looking projections perhaps as much as the tax bill did.
On Jan. 19, the committee publicly presented the projections it gave the Federal Reserve’s FOMC earlier in the week.
“Despite experiencing just about every disaster that Mother Nature could throw at us last year, the second half of 2017 saw a growth average around 3 percent,” said Ellen Zentner, chair of the 14-member group and chief U.S. economist for Morgan Stanley. “As we came to the end of 2017, we saw business sentiment surveys and consumer sentiment surveys now at or near record highs. That’s a very good macro backdrop as we’re entering 2018.”
Finishing 2017 near 3 percent growth outpaced the committee’s June projections of 2 to 2.2 percent, per the central tendencies. The tax reform’s greatest effects will not be felt in the near-term, but the committee still attributes about 0.5 percent of coming growth to the reform, putting its consensus at 2.4 percent for 2018.
Combining that growth with a continued decrease in the unemployment rate will further the economy’s growth. The committee projects unemployment to fall each quarter this year, reaching 3.8 percent to close 2018. After falling even further in 2019, the committee projects unemployment to hold at 3.9 to 4.4 percent in the long run. These are all lower estimates than the committee offered in June.
The strengthened labor market and ensuing higher wages has already begun influencing businesses to invest in their own capital and infrastructure, which will moderate just how far unemployment falls.
“An enduring feature of every business expansion is at some point labor costs rise enough that it starts to shift businesses back toward capital expenditures,” Zentner said. “That tradeoff between the cost of labor and the cost of capital starts to favor capital. That is one of the organic shifts we saw in the cycle.
“We saw last year, alongside the recovery in energy and infrastructure investment, … a big pick up in equipment investment. That is the backdrop coming into newly-enacted tax policy changes that we feel provide a good further tailwind to what was already a healthy environment for business investment.”
The exact trends of the long-term effects of the tax reform are difficult to project, casting a higher than usual degree of uncertainty to the committee’s projections. The majority of the committee expects any error to come in not predicting enough of an economic upside. Nine of the members would expect even greater real GDP growth, if the projections are indeed wrong. None of them could envision less business investment than projected.
“We talked about risks to the upside including an even stronger pace for wage gain spurred by consumer spending or higher than expected investments due to corporate tax cuts when we already have a very positive investment backdrop in our outlook,” Zentner said. “A lot of the uncertainty around the forecast depends on where households put those additional tax dollars that they didn’t originally have in their budgets this year, and what is the tradeoff of business decisions between investments, share buybacks, dividends, increased M&A, raising compensation of workers.”
None of the projections factored in any infrastructure bill, another possible push toward outperforming these numbers.
Zentner made a distinct point of noting more time was spent on what could tick the economy upward than on what might slow it down. The former appears that much more likely than the latter. The few possibilities that would halt continued economic growth include higher than expected inflation, a sharp asset price correction, a breakdown in trade negotiations and any geopolitical shock.
The committee expects three fed funds rate increases in 2018 and two more in 2019. It projected conventional mortgage rates to reach 4.35 percent in 2018’s second quarter and 4.58 percent by year’s end.
The committee estimates only a 15 percent probability of recession in 2018, rising to 30 percent in 2020.
On the government shutdown
Looking back to the most recent government shutdown, more than four years ago, Zentner does not expect much of a long-term effect to come from the current situation. In areas with large numbers of federal employees, some industries may feel slight effects in the short term. Zentner’s example pointed to those employees no longer getting lunch every day, denting the restaurant industry’s profits for the month.
In 2013, the long-term effects came in an intangible manner.
“Where we did see a lasting effect, though, was in business sentiment and consumer sentiment,” Zentner said. “No one likes the uncertainty of a government shutdown.”