U.S. outlook for 2019
Associate Professor Emeritus, Department of Economics, Indiana University Bloomington
A year ago, we expected that 2018 would represent a step up from the “new normal” of 2.1 percent economic growth to a little above 2.5 percent, but we also said there was upside potential to about 3.0 percent growth if tax reform were enacted.
We expect now that 2018 will end up with output growth somewhat above that level (see Figure 1). We did not anticipate the additional boost from the budget deal on the spending side of the federal budget. This looks to add about 0.3 percent to GDP growth above what we expected. Other deviations from our forecast essentially balance out: Consumption and housing a little below our expectations were offset by stronger business investment; improvement in the trade deficit was offset by lower inventory accumulation.
Figure 1: Rate of change in U.S. real output
Source: U.S. Bureau of Economic Analysis
The labor market is headed for another good year—and for the second year in a row better than our forecast. A year ago, we predicted that the economy would create jobs at a monthly rate around 175,000 and that the unemployment rate would fall a little to perhaps 4 percent. Instead, through October job creation has averaged 213,000, while unemployment has declined to 3.7 percent (see Figure 2). As we expected, the labor force participation rate (the proportion of the working-age population that is active in the labor market) has been stable.
Figure 2: U.S. monthly job creation and unemployment rate, January 2015 to October 2018
Source: U.S. Bureau of Labor Statistics
Overall, the performance of the economy during 2018 has been positive, which is encouraging for the year ahead.
Looking to that future, we are forecasting another good year for the economy. But we do so with some quivers of dread. A few specifics:
- We expect output growth in 2019 to average close to 3 percent, but with deceleration as the year proceeds. By this time next year, quarterly growth will be below 3 percent heading toward equilibrium growth at a little below 2.5 percent.
- Job creation will continue the trends seen in 2018: Job gains will average close to 200,000 per month, with the participation rate flat.
- The labor market will be increasingly tight. The unemployment rate could decline a little, and firms unable to find workers will remain an important theme.
- Consumer spending will continue to advance, although at a rate below this year. Business investment will be good, but held back by trade worries. Housing will resume growth with a small boost from the aftermath of hurricanes Florence and Michael. Government spending will be strong early in the year, but growth could slow significantly toward the year’s end. The trade balance will show increasing deficits.
- The Federal Reserve will continue to raise rates, with the federal funds rate close to 3 percent by the end of 2019.
There are, however, very significant risks in the current environment, which could unquestionably cause an outcome worse than we expect. A short list:
- The Trump administration (and the political situation more generally) adds a large dose of uncertainty to the outlook, especially given the split in partisan control of Congress. This uncertainty alone raises downside risk.
- Significant further moves toward trade protection carry large economic risks. The recent agreement with Mexico and Canada (USMCA) is a positive development—even though it is probably a small step backwards from the NAFTA status quo. Like it or not, the U.S. economy is totally integrated into a global system. Efforts to limit imports, particularly from China, would inevitably affect international supply chains in ways that would be highly disruptive for domestic production. And the politics of a deal with China are more difficult than the USMCA agreement.
- The international state of affairs contains a multiplicity of other problems. The Chinese economy faces serious structural problems (which is part of the reason a trade deal is going to be tough). 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 also faces underlying debt problems, and Brexit is a tough problem both for the U.K. and the European Union.
- We have long felt that Federal Reserve policy has produced significant distortions in the financial sector that at some point would have to be corrected. That process is now underway and, by the end of 2019, will be approaching the point where continuing to raise rates becomes problematic.
To summarize: In line with our forecast a year ago, the tax cut has produced an acceleration in the U.S. economy during 2018 to well above the new-normal status quo. Our outlook is for a continuation of this improvement during 2019. But there is massive uncertainty in the current situation. A year from now, we will hopefully report that the economy in 2019 has matched our optimistic expectations. But the risks that we might be wrong are totally to the downside.