Real GDP grew at an annual rate of 1.9 percent in the last three months of 2016. That’s a slowdown from the pumped up 3.5 percent rate of the prior quarter and a bit of a downside miss off of the market expectation for a 2.2 percent growth rate for the quarter.
But like it or not, the underlying trend growth rate of US GDP is 2 percent, and today’s report is solidly on that trend. I know there’s been lots of magical talk about hitting 4-6 percent targets by the incoming administration, and if that’s your benchmark, 2 percent looks awfully “meh.” But that benchmark is based solely on wishful thinking leavened by unwarranted faith in alleged growth effects from tax cuts and deregulation.
A few notable stats from the report:
–Net exports, a pretty highly charged topic right now, were a significant drag on growth, subtracting a big 1.7 percentage points off of the topline number. Exports sagged and imports sizzled, as Marketwatch put it, with imports (a negative for GDP) posting their biggest growth rate (8.3 percent) in two years. Part of this is due to something you’ve heard me worry about in recent posts: the strength of the dollar. But part is bounceback from a strong contribution from net exports in Q3 based on a spike in soybean exports.
–Inflation in the report may raise some eyebrows, as the PCE deflator, closely watched by the Fed, rose 2.2 percent in Q4, its fastest pace since 2012. But I don’t think this builds the FOMC hawks’ case much at all. First, the 2.2 is the quarterly value, annualized, and the Fed – correctly, given its higher signal-to-noise ratio – prefers year-over-year measures. On that basis, the PCE is up 1.5 percent, a clear acceleration over prior quarters, as energy prices have picked up some, but still far below the Fed’s 2 percent target, which they’ve missed now for years running (see figure). The core PCE, which takes out energy and food, was up 1.7%, yr/yr, just about where it’s been over the past 4 quarters.
Is inflation accelerating? It certainly looks to be, which is what you’d expect as the job market nears full employment and energy prices edge up from historical lows. That’s exactly what you’d expect at this point in the cycle and, especially considering the fact that GDP is growing right at its trend, I see no signs–none, nada, zip–of overheating, and I strongly suspect that’s where Chair Yellen is as well.
Should we be bummed out by the 2 percent growth trend? Why can’t we hit bigger growth numbers, damnit!?
The trend is not a function of political bloviation about the fairy dust of tax cuts, kissing up to the “job creators,” releasing business from the “chains of regulation,” Tweet-shaming trading partners, and the rest of the nonsense that coming out of the increasingly weird place that is DC these days.
Trend growth is instead a function of the growth of the labor force and productivity. The former has slowed in part for demographic reasons and in part due to weak labor demand that persists in parts of the country even as the overall economy nears full employment -all the more reason for the Fed to hold their fire, especially given the absence of overheating evidence.
Productivity growth is in the midst of a serious slowdown and that really is a problem, one that we really should be having non-delusional conversations about (versus how we’re going to get Mexico to pay for the wall…).
Finally, as I’ve written lately, we need to pay attention to the strengthening dollar which, by making our exports less price competitive, threatens to swell the trade deficit. The value of the dollar is rising in no small part because our 2 percent trend growth rate, tightening job market, and slowly increasing Fed funds rate all draw in capital from the rest of the world, wherein other advanced economies are still struggling, supported by low and even negative central bank rates. Those flows and growth dynamics boost the dollar, which is up more than 20 percent since mid-2014.
Still, as I point out here, the dollar is overvalued for other reasons as well, including currency management tactics by some trading partners. That warrants a policy response.
In sum, there’s no substantive reason to suggest the Q4 report signals anything other than trend growth in a climate of low inflation. A smart discussion of how to boost that rate would involve how to pull in those still on the labor-market sidelines, what’s holding back productivity (weak private and public investment, even at very low interest rates, is a suspect, as is the long-term absence of full employment), and dollar policy.
That is not, however, the conversation we are having, or, I fear, destined to have in the near future.