Recent readings for the U.S. economy are filled with contradictions. Non-farm payroll gains were quite strong. Unemployment fell to 5.7% from 6.1%, last September. Nonetheless, real GDP growth was soft, up only 2.6%. And retail sales were quite weak. Reconciling robust gains for employee hours and a low jobless rate with tepid increases for real GDP and soft nominal spending gains is very difficult.
The most recent Survey of Professional Forecasters suggests that forecasters generally reconciled these contradictions by doing the following:
Assume a nearly instantaneous sharp slowdown for job growth.
Project a modest additional decline for unemployment.
Assume a continuation of unprecedented weakness for labor productivity growth.
Project a modest pace of advance for real GDP.
Assume almost no change for core inflation.
Specifically, for 2015 the recent survey has:
Non-farm payroll gains average 238,000/month. This compares to the 336,000 average monthly gains of the past 3 months, the 282,000 average monthly gains of the past 6 months, and the 267,000 average monthly gains of the past 12 months.
Unemployment falls to 5.2% in Q4:2015 By sharply curtailing the pace of job growth, over the four quarters of 2015, forecasters avoided writing down projections that took unemployment below 5%. They also avoided projecting a rebound for the participation rate.
Labor productivity rises by a tepid 0.8% Notwithstanding the slower pace for job growth, that growth would still suggest a gain for employee hours of roughly 2%. A traditional projection for labor productivity, say a gain of 1.8%, would require forecasters to embrace hefty gains for real GDP. Instead, labor productivity gains are consigned to rise by less than 1%.
Real GDP climbs by 2.8% Embracing evidence of soft nominal consumer spending trajectories, and acknowledging the likely drag on output that trade will deliver, real GDP growth is projected to approximate the pace registered in Q4:2014, a pace well short of the gains witnessed in Q2:2014 and Q3:2014.
Core inflation is projected to remain steady, rising 1.7% in 2015. All forecasters know that gasoline prices have plunged and that headline inflation will fall for a few months, simply a consequence of petroleum product price declines. Beyond that, however, the consensus forecast looks for little change, anticipating a 1.3% rise in core inflation in Q1:2015, followed by a 1.8% rate of inflation for the remainder of the year.
What is the most striking aspect of the consensus view? Almost to a person, forecasters felt compelled to sharply rein in jobs growth. The current recovery reminds us that one should never doubt dire predictions, but where is the evidence for a sharp deceleration? Should this really be the modal forecast? Plunging petroleum prices, history makes fairly clear, act as a stimulus in the U.S. It is true that the rise for the dollar and the fade for economic growth in Europe, Japan and China all combine to suggest that trade will be a drag on real growth in 2015. That said, netting out the effects of rest-of-world weakness against a halving of the U.S. consumer energy bill, probably suggests a small positive change in U.S. economic momentum.
I suspect that the projected, sharp job market retrenchment is not due to signs of weakness. Instead, I suspect it is because of the forecasting havoc that continued strong job growth would bring to the rest of the forecast.
Some simple arithmetic
Suppose job growth does not slow, and instead climbs at the average pace in place over the past 3 months? Suppose further that labor force participation is stable, as it was over the four quarters of 2014. The jobless rate, in such circumstances falls to 4.1%. In addition, total hours worked will have climbed at a 2.7% pace. With all that, one would be forced to forecast a rise for real GDP of nearly 4%, even if one embraces the notion of a tepid, less than 1% climb for labor productivity.
How can we invent a climb for real GDP of nearly 4%, amid tame nominal spending trajectories and stable core inflation? That’s simple. We can’t.
Suppose instead that we temper our enthusiasm for job strength and we embrace the trajectory in place over the past 6 months. And, once again, let’s assume an extension of a stable participation rate. In this case, Unemployment, Q4:2015, averages 4.5%. And we still need to contrive a story that allows for real GDP growth of around 3.5%, amid soft spending trajectories and core inflation a bit below 2%. Again, a very tough story to cobble together.
This daunting accounting, I suspect, helps explain the willingness to envision a violent job growth downshift. Accepting recent jobs trajectories boxes you into other storylines that you are not ready to tell. Jettison the jobs strength and it is much easier to roll out consensus views for much of the rest of your forecast.
Thinking inside the box
Is there any way to keep the jobs strength and tell a plausible economy wide story while remaining boxed in by the confusing configuration of recent data? One way to do so requires us to make two leaps. Bet on a major fall for core inflation. And assert that labor force participation, at long, long last, is now on the rise. Second things first. Over the 7 years through Q4:2013, the participation rate fell at a 0.8% per year pace. What happens if it rises by 0.8% in 2015? Put the rate at 63.3% and the jobless rate averages 5% in Q4:2015, even with monthly job gains running at 330,000 throughout the year. Throttle back the job growth assumption to the six month trajectory and what happens? A year of 280,000 per month job gains ends with the jobless rate at 5.3%. What about output growth? January’s import price data may give us the key. Core prices fell sharply, by 0.6%, month-on-month. They were down 1.1% year-on-year. Moreover the data show a clear acceleration on the downside. This is all too easy to explain. There is always an echo effect in other prices, when energy prices plunge. We also have a 15% rise for the U.S. dollar versus a very wide basket of U.S. trading partners’ currencies. Lastly all indications suggest that inflation in China is in sharp retreat. This suggests prices of goods sent from China could fade this year. Suppose the consensus assumption about core inflation is wrong? If core inflation falls to 0.7%, we have a percentage point of additional real growth, for any given level of nominal spending growth. We can, therefore, assert the following. Real GDP growth of 3.5% to 4% is achievable without a material acceleration for spending, if core inflation fades in 2015. Furthermore, in this scenario, the jobless rate can end the year a bit above 5%, notwithstanding strong gains for monthly payrolls. We simply need to embrace the notion of a bit of bounce back in the participation rate, after 7 very lean years. What about tepid productivity? We get labor productivity up to 1.5% in a world of 280,000 per month job gains and 4% real GDP. Not an impressive number. But one that does not conjure up bleak stories of continued malaise in the aftermath of the Great Recession.
The CFE forecast
In broad terms, the story just given explains what our forecasting team here at the CFE submitted to the Survey of Professional Forecasters. Let’s be clear, like the other forecasters, we are sometimes right in key features of our forecast, always wrong somewhere, and occasionally wrong in general. One of the most important reasons for making a forecast, however, is that it forces one to devise a story that most plausibly reconciles all the available data. With the current confusing constellation of data, this is really making a story that is least implausible. Most forecasters seem to have concentrated the implausible part mainly on job growth. We have spread it around a bit more in a way that we think is worth considering.