U.S. outlook for 2017
Associate Professor Emeritus, Department of Economics, Indiana University Bloomington
An observer of the political scene recently said, “I try to be cynical, but I just can’t keep up.” As an economic prognosticator, I feel a little the same. I try to be pessimistic (or at least not optimistic), but I just can’t keep up.
Two years ago, our forecast for 2015 had the economy breaking out of its “2 percent slog” to growth of nearly 3 percent. The actual number was 1.9 percent (fourth quarter to fourth quarter). A year ago, looking ahead to 2016, we saw “little reason for any real optimism,” but we did think growth would reach about 2.5 percent, thus surpassing 2015. It now looks like 2016 will struggle to reach even 2 percent. Over the first three quarters, real GDP has averaged just 1.8 percent (see Figure 1).
Figure 1: Rate of change in U.S. real output
Source: U.S. Bureau of Economic Analysis
So, what went wrong? Nothing really dramatic. First, the business, housing and government sectors all underperformed relative to our expectations. We had expected business investment to increase at a 3.7 percent rate, building on improving growth in 2015; instead (based on the first three quarters of 2016), it collapsed to -0.8 percent. Housing was similar—expected growth of 5.8 percent turned into an actual decline of -1.7 percent. Government was less dramatic, with actual growth below 0.1 percent versus our forecast of 0.8 percent. In total, these three sectors pulled output down by almost 1 percent relative to our expectation. (Exports would also have underperformed except for a huge third-quarter jump in soybeans exports. This alone added as much as a quarter point to overall Q1-Q3 growth.) However, consumption offset some of these shortfalls—consumption has grown at a 2.9 percent rate, a little above our forecasted 2.5 percent.
Output in the third quarter of 2016 increased at an annual rate of 3.2 percent. This was better than the 1.1 percent average for the first half of 2016. However, an increase in inventories and the soybean factor mentioned above accounted for about 1 percent of that third-quarter advance.
In the labor market, the economy added 161,000 jobs in October (see Figure 2). For the first 10 months of 2016, the monthly average was 181,000. This is significantly below the average of 229,000 for all of 2015. The unemployment rate in October was 4.9 percent, essentially unchanged from the beginning of the year.
Figure 2: U.S. monthly job creation and unemployment rate, January 2013 to October 2016
Source: U.S. Bureau of Labor Statistics
Overall, 2016 must be rated as mildly disappointing. Growth has been weak, but that is nothing new. It is a continuation of the pattern of the previous six years. Job creation has slowed and the decline in unemployment seems to have ended. This is to be expected as the labor market approaches full employment. The household sector is in good shape and consumption has been quite strong. At the same time, every other part of the economy is lackluster or worse. This lack of balance is troubling for the present and unsustainable for the future.
Looking to the future, we see little reason for any real optimism, but we do think the economy will continue to muddle through, matching the past year—or perhaps a little better. This outcome depends on at least some improvement in investment (both business and housing) and government spending. This will offset a modest deceleration in consumer spending, bringing the latter into better balance with income growth. Some specifics:
- We expect output growth in 2017 to average slightly above 2 percent. This will about match the past year. It represents a continuation of the pattern that has been in place since 2011.
- The labor market will continue the trends seen in 2016—job gains will average below 150,000 per month, with little, if any, decrease in the unemployment rate. By the end of 2017, the rate will remain below 5 percent, but only by a tick or two.
- As we expected, inflation moved up during 2016 and will average about 1.5 percent for the year. We think this trend will continue in 2017, with the personal consumption expenditures measure preferred by the Fed reaching their target 2 percent rate by year's end.
- Consumer spending will continue to advance, but at a rate below this year. Business investment and housing will resume growth, but at rates below those earlier in the recovery. The trade balance will experience further deterioration, even with some increase in export growth.
- The Fed finally raised rates at the very end of 2015, but has been sitting on its hands since. We think it will raise rates in December 2016 and then twice more during 2017.
This is a more pessimistic outlook than we presented a year ago, but it could easily prove (once again) to be too optimistic. There are significant risks in the current environment that could cause a worse outcome than we expect. A short list:
- The international state of affairs contains a multiplicity of potential problems:
- The Chinese situation seems to have stabilized lately, but very serious structural problems remain to be addressed. At the top of this list is the need to shift the economy from a focus on infrastructure and investment to a more consumer-driven structure. Close behind is a serious internal debt problem.
- Europe has also been doing a little better recently, but mostly due to monetary stimulus. There is little, if any, progress being made on their underlying structural problems, with debt problems again a prominent feature. In addition, the migrant crisis continues to produce political pressures whose ultimate effects are highly unpredictable, but unlikely to be productive for the economy. The Brexit vote is indicative of these forces.
- We continue to feel that Federal Reserve policy has produced significant distortions in the financial sector that at some point will be corrected. While any Fed move on rates would, taken alone, have little effect, the economic consequences could be far more dramatic if it triggered a broader financial market event.
The election of Mr. Trump adds a large dose of uncertainty to the outlook. This uncertainty adds to the downside risks, but also creates some upside potential.
- On the negative side, significant moves toward protectionism—either on trade or immigration—carry large economic risks. Like it or not, the U.S. economy is totally integrated into a global system. Efforts to limit imports, say from Mexico or China, would inevitably affect international supply chains in ways that would be highly disruptive for domestic production.
- On the positive side, action to enact tax reform or a long-term program of infrastructure investment could have a positive impact. Regulatory changes that put more emphasis on economic costs could as well.
The U.S. economy has underperformed during 2016, even relative to our diminished expectations a year ago. Our outlook is for some improvement during 2017, although only a little. But the massive uncertainty in the current situation could make our pessimism end up being wishful thinking. Or perhaps a year from now we will report that in 2017 the economy has (finally) outperformed our expectations.