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Indiana University Bloomington

Center for Econometric Model Research

United States Forecast Summary

February 2016

 

Even relative to low expectations the initial data for the fourth quarter were disappointing. This disappointment capped a month of downbeat news. Reacting to continuing worries about China, both the stock market and oil fell dramatically. Monthly indicators continued to be weak. The result is that our forecast has shifted from moderate optimism to definite pessimism.

NIPA Data

The initial National Income and Product Account estimates for the fourth quarter were quite disappointing. Overall output growth was put at an annual rate of just 0.7%. Growth in final sales (which ignores a negative effect from inventories) was a very weak 1.1%. For comparison, over the previous four quarters total GDP and final sales averaged growth of 2.2% and 2.1%, respectively.

It was widely reported in the media that growth for all of 2015 was 2.4%, virtually unchanged from 2014. This calculation is based on annual average real GDP for the two years, and was emphasized in the BEA press release. But comparing annual averages can often give a distorted picture of events during the four quarters of a year. In Figure 1 the Year/Year line measures growth for a particular quarter relative to the same quarter the year before. Using this metric, growth for the four quarters of 2015 was just 1.8%, compared with 2.5% for the four quarters of 2014.


At a disaggregate level this picture of deceleration finds definite affirmation. As can be seen in the table below there was clear deterioration in the growth of every component of aggregate demand during the second half of last year.

 
2015Q2
2015Q3
2015Q4
Consumption
3.6%
3.0%
2.2%
Business Investment
4.1%
2.6%
-1.8%
Housing
9.4%
8.2%
8.2%
Government
2.6%
1.8%
0.7%
Trade Deficit Change*
-$5.6B
+$11.5B
+$20.4B
  * A negative value indicates shrinkage in the deficit, which has a positive impact on growth

 

Over the past year our forecast has become steadily more pessimistic. The data for the fourth quarter suggests we still have a ways to go.

 

Recent Monthly Data

The pattern of monthly indicators has exhibited considerable recent consistency. Measures relating to the household sector have been encouraging, while those from the business and trade sectors have been dismal. These general patterns persisted during the past month.

The household sector had solid growth in income in December, discretionary income was again boosted by declining gasoline prices, and consumer sentiment showed further improvement in January (even in the face of the turmoil in the stock market). Yet households continued to show an inclination for saving over spending. The personal saving rate in December was 5.5%, matching October for its highest level since 2012. Housing starts and building permits both fell in December, but have exhibited a relatively consistent upward trend over the past three years at a very solid average rate above 7%.


The picture from the business side of the economy, on the other hand, remains disturbing:

  • Industrial production fell in December. During 2015 it increased only twice (in July and August). Overall it declined 1.8% last year. The IP index for manufacturing was also down in December, and rose just 0.8% for the year.
  • New orders for all durable goods in December fell 2.9% (monthly rate). For the full year the decline was 4.2% (Dec/Dec, annual rate). For nondefense capital goods, excluding aircraft (a proxy for business investment in equipment) the corresponding numbers were -4.3% and -7.4%.
  • The ISM indices for January were mixed. The manufacturing index rose marginally, but remained below 50. January marks four months in contractionary territory. The non-manufacturing index declined for the third consecutive month. Its reading of 53.5 still indicates expansion, but with significantly less exuberance than six months ago.


Finally, the employment report for January contained support for both optimists and pessimists. As with the indicators just discussed, the data from the household side was positive and that from the business side was mostly negative. The household survey produced a decrease in the unemployment rate to 4.9%. Just as encouraging the drop came in the context of a significant increase in the labor force. Less encouraging, the establishment survey had an employment increase from December of just 151 thousand. This was below expectations, and significantly down from the 279 thousand average of the previous three months. But this survey also had a solid increase in average weekly earnings. Over the past year earnings now show an increase of 2.5%.


Adding this monthly data to the disappointing NIPA data for the fourth quarter data provides us with little cause for optimism as the economy enters 2016.

 

Baseline Forecast

As can be seen in the chart below, our new forecast is decidedly less optimistic for the next four years than our outlook three months ago. For 2016 growth in output averages 1.8%. This matches growth during 2015, but is down 0.6% from our November forecast. The reduced growth comes from every sector except housing. The largest contribution (about one-third) comes from a larger rise in the trade deficit. Consumption and business investment each account for about one-quarter, with the rest coming between inventory accumulation and government.

 

                        

Adding this monthly data to the disappointing NIPA data for the fourth quarter data provides us with little cause for optimism as the economy enters 2016.

 

Some further aspects of our baseline scenario:

  • During the course of 2016 the growth rate of business investment increases, while that for residential investment slows a little. Growth rates for consumption and for government spending are both close to stable.
  • Unemployment declines only slightly from its current level, ending the forecast period at 4.8%, which represents full employment in our model. The participation rate, driven by demographic factors, resumes a slow decline.
  • As a result, employment growth decelerates during 2016 to below 140 thousand per month in the fourth quarter, down by 100 thousand from the fourth quarter of last year.
  • We assume the WTI oil price rises slowly from its current level in the $30s to the mid-$50 range by the end of the forecast. The exchange rate is assumed to continue appreciating through the forecast, but at a rate significantly below that seen during the past year.

 

Summary

Our model has finally surrendered to the “new normal.” For the full forecast period our forecast now puts GDP growth at 2.1%, just a hair above the average for the past four years.

Our baseline scenario implies that the current expansion would reach over ten years in duration. Given the long list of negative risks this seems quite unlikely. In a slow growth economy the margin for error is less than if normal is growth of 3-4%. At the same time, the economy currently has no really significant imbalances. After the past month, even the financial markets are less inflated. That does not at all guarantee that a couple of adverse shocks couldn’t put the economy into negative territory. But it could mean that any slowdown would not be really severe.