Summary: Today’s economic forecast by the Fed gives us another dose of bad news, wrongly overshadowed by their decision not to raise interest rates (resulting from it). Ignore economists’ guessing about the next tick up or down in the economy. The key insight is that America can’t grow fast but cannot afford to slow. {2nd of 2 posts today.}
Content
- A darkening Fed forecast
- America in the “coffin corner”
- For More Information
(1) A darkening Fed forecast
The Fed’s forecasts get too little attention, although they play a large role in the setting of Fed monetary policy. Since the crash the Fed has started its out-year forecasts high, and then dropped them at an accelerating rate as they approach the present. The high end of 2015 has fallen 40% vs. a fall of only 4% for 2017. Hope dies slowly.
- 2015 from 3.0 – 3.8% in Sept 2012 to 2.0% – 2.3% now.
- 2016 from 2.5 – 3.3% in Sept 2013 to 2.2% – 2.6% now.
- 2017 from 2.3 – 2.5% in Sept 2014 to 2.0% – 2.4% now.
- 2018 started at 1.8% – 2.2% (median of 2.0%).
As this graph shows, since the crash, GDP has swung between 1% and 3%. When GDP falls below 2% the odds of a recession rise rapidly. This recovery already has had two close calls. The Fed responded to the slowdown that began in Q4 2010 with QE2 (Nov 2010), and to the slowing that began in Q2 2012 with QE3 (Sept 2012).
America’s economy in the “coffin corner”
Readers of the FM website have seen my long-standing prediction of this situation. Most clearly started in The dilemma of the US economy: can’t take off & too close to the brink. Lombard Street Research described it more analytically in Has America’s economy entered the “coffin corner”?
The question is whether advanced economies, in an effort of trying to limit the damage caused by the Global Financial Crisis, have put themselves into a debt coffin corner. With debt-to-GDP (altitude) as high as it is, they can’t allow growth (airspeed) to slow too much, or debt risks becoming unsustainable. At the same time, high debt levels are likely to be a material drag, making growth hit an insurmountable economic “sound barrier” much earlier. This is because without the boost provided by credit growth, it is difficult to achieve the kind of GDP growth that was possible when debt-to-GDP was lower.
But there’s more. High levels of debt-to-GDP ratios make it difficult for governments and central banks to steer the economy – just as excessively high altitude makes it difficult for a pilot to keep control of the aircraft. Central banks have successfully employed Zero interest rates policy (ZIRP) to keep debt sustainable but, as the economy continues to recover, they may now find themselves cornered: keeping rates as low as they are may lead to overheating (or even bubbles) in certain sectors of the economy; but raising them may stall others by making the existing debt impossible to service.
I strongly recommend reading those two posts. You’ll probably gain more from them than reading today’s flood of information guessing about the next tick up or down in the markets and the economy. We are not in a normal business cycle. Until we see that, we understand nothing about the situation of the economy.
Only bold action can break us out of this dilemma, measures now politically unacceptable. But they’ll quickly become mainstream when we fall into the next recession (given our weak condition, any shock could push us over). I suspect it will be quite exciting.