I’m hearing a fair bit of optimism re the current economy. Many of the folks with whom I interact on this stuff are feeling better about where things are headed, with unemployment down, households looking pretty deleveraged, job growth at a decent clip, and the weather-beaten data flow improving.
As Mark Zandi wrote in his (invaluable) monthly macro report:
Awful winter weather, the expiration of the emergency unemployment insurance program, and slower inventory accumulation hurt growth at the start of the year. However, as their impact fades, the strength of the underlying economy is increasingly evident.
OK, I can see that. And I don’t want to be the skunk at the garden party. But in the interest of contrarianism, this seems like a good time to list some downside risks. Feel free to add your own in comments.
–“Secular stagnation” or the idea of persistently weak demand. Getting back to trend GDP growth, which discounting the near-zero print on Q1 GDP, is about where we are, is an insufficient new normal because we’re still stuck with large output gaps and high non-employment.
–Speaking of that, the steady decline in the labor force is another risk, both at the micro (um…working-age people need paychecks) and macro level (output growth=productivity growth + labor force growth).
—Housing (which Zandi, who covers the sector closely, worries about as well in the report noted above) has slowed in recent months. You can look at indicators like the huge slide in homeownership rates coming off the bubble or the historically low share of housing investment in GDP—around 3% versus an historical average a bit below 5%–and decide they’re poised to bounce back as there’s deep untapped demand for new household formation. Or you can conclude that credit’s still too tight, mortgage rates are climbing, as are home prices (supply-constraints?), and connect these concerns to weak jobs and incomes among those not in the top 1%.
—Fiscal headwinds are down but they’re not out, and Congress continues to block needed investment as well as help for the long-term unemployed. In fact, the US Congress is a pretty worrisome economic risk factor.
—Wages remain weak as I’ve shown in various places and dis-inflation is also a concern.
–Re that last point, we’re still stuck at the zero lower bound and the equilibrium real interest rate—the one we need to clear the investment market—is still below zero. Since at the ZLB, the real rate is the negative of the inflation rate, dis-inflation—the fact that the core PCE is basically down from 2% to 1%–pushes in the wrong direction.
—Inequality: Related to the weak wage growth point; remember, we’re still a 70% consumption economy; as long as growth eludes most households—and we’re talking about the ones with higher consumption propensities—consumer spending could stumble.
—Euro/China weakness: Especially as the budget deficit has fallen quickly (fiscal drag), we really don’t need our trade deficit to expand. It’s C+I+G+NX, and with G falling we don’t need net exports contracting.
—Fed stumble or market overreaction: The market’s already been through a taper tantrum, so that’s behind us, but I recently worried that while Fed targets–inflation and job growth–seem somewhat less elastic to monetary policy, market reactions, from yields on bonds to international currency flows seem more elastic. Or at least more skittish. So there’s market risk as the Fed unwinds and ultimately lifts the funds rate off of the floor.
Like I said, the long winter may really be over and none of these will darken our economy’s doorstep. But I’ll be watching out for all the above, just in case.