posted on 18 April 2016
from Liberty Street Economics
-- this post authored by Jonathan McCarthy, Richard Peach, and Robert Rich
Last Friday, the Federal Reserve Bank of New York (FRBNY) hosted the spring meeting of its Economic Advisory Panel (EAP). As has become the custom at this meeting, the FRBNY staff is presenting its forecast for U.S. growth, inflation, and the unemployment rate.
Following the presentation, members of the EAP, which consists of leading economists in academia and the private sector, are asked to critique the staff forecast. Such feedback helps the staff evaluate the assumptions and reasoning underlying its forecast as well as the forecast's key risks. The feedback is also an important part of the forecasting process because it informs the staff's discussions with New York Fed President William Dudley about economic conditions. In that same spirit, we are sharing a short summary of the staff forecast in this post; for more detail, see the FRBNY Staff Outlook Presentation from the EAP meeting on our website.
Staff Forecast Summary
Here we discuss the FRBNY staff forecast for real GDP growth, the unemployment rate, and inflation in 2016 and 2017.
In our forecast released last May, we anticipated a slowing of growth in 2015 to about 2 percent (Q4/Q4) from around 2½ percent in 2014. The predicted slowing was due primarily to the effects of dollar appreciation and weaker growth among our major trading partners, as well as weaker domestic energy investment resulting from substantially lower oil prices. These sources of weakness were expected to be partially offset by faster growth of household spending owing to the boost to real disposable income from lower energy prices.
As it turned out, the appreciation of the dollar and the decline of drilling activity were both larger than anticipated, resulting in weaker-than-expected growth over the second half of 2015. Nonetheless, the 2 percent (Q4/Q4) growth rate of 2015 was above the economy's potential growth rate, resulting in a further decline of unemployment and some firming of core inflation at the end of the year.
Last year's forecast envisioned that growth would firm to around 2½ percent in 2016 as the forces restraining growth would begin to wane. In our current forecast, however, we expect growth in 2016 to remain around 2 percent. Available data suggest that growth in the first quarter of 2016 was sluggish. But over the remainder of 2016, we expect growth to be around 2½ percent (at an annual rate), supported by generally favorable underlying fundamentals: fairly healthy household and business balance sheets, slightly stimulative fiscal policy, and still-accommodative monetary policy. Moreover, a significant inventory correction is expected to draw to a close over the first half of the year, while the restraining forces mentioned above are still expected to fade.
Consumer spending is anticipated to grow around 2½ percent, slightly slower than in 2015, as real income growth is sustained through faster growth of compensation and low overall inflation. Residential investment growth is expected to increase somewhat, supported by continued improvement in the labor market and low mortgage interest rates. Business fixed investment is expected to begin to recover as oil and gas drilling stabilizes and the manufacturing capacity utilization rate moves higher, but that recovery should still be fairly subdued. These developments favorable to growth will likely be offset to some extent by a continued substantial drag from net exports.
While lower than last year's forecast, projected growth in 2016 will remain above the economy's potential growth rate - which we now estimate to be 1¾ percent. As a result, the unemployment rate should decline by the end of this year to around 4¾ percent, which is our estimate of the unemployment rate associated with stable inflation. Inflation, as measured by the personal consumption expenditures (PCE) deflator, should move gradually higher with relatively stable energy and import prices, but remain below the FOMC's longer-run objective of 2 percent.
For 2017, we expect growth of real GDP to slow to a pace close to our estimate of potential growth because much of the resource slack in the economy is likely to have dissipated by then. The unemployment rate is expected to be roughly stable, with productivity growth gradually moving up to its long-term trend of 1¼ percent to 1½ percent (on a nonfarm business sector basis). In addition, the staff anticipates that the labor force participation rate will stabilize in 2017. Inflation is expected to approach the FOMC's objective owing in part to well-anchored inflation expectations.
Comparison to the Blue Chip Forecast
Here, we compare the New York Fed staff forecast to the consensus forecast from the April Blue Chip Economic Indicators, published on April 10. The staff forecast for real GDP growth is similar to the Blue Chip consensus forecast for most of 2016, but is below the consensus and near the average of the ten lowest forecasts for 2017. For consumer spending over these two years, the differences between the FRBNY staff and Blue Chip consensus forecasts are fairly small, but the FRBNY staff forecast anticipates that net exports will be a more substantial drag on growth, particularly in 2017. In part because of weaker GDP growth, the FRBNY staff forecast projects a somewhat higher path for the unemployment rate than the Blue Chip consensus. Even with these differences in real side forecasts, the inflation forecasts are roughly similar.
Risks to Staff Forecast
An important part of the staff analysis of the economic outlook is the assessment of the risks to the forecast. The staff sees the risks to our projection for real growth to be skewed somewhat to the downside over the forecast horizon. The key downside risks are that financial conditions will tighten more than assumed in the staff forecast and that slower global economic growth could have a larger spillover to U.S. growth. On the upside, the notable risk is that the underlying fundamentals for consumer spending and housing will turn out to be stronger than expected.
For inflation, the risks are roughly balanced for 2016, but slightly skewed to the downside for 2017. The downside risks include stronger global disinflation pressures than expected as well as the possibility that, with inflation running below the FOMC's objective for so long, inflation expectations become unanchored to the downside. Among the upside risks are the possibility of less-than-expected resource slack, a more modest effect of dollar appreciation on domestic prices, and a possible reversal of the past several years' slowdown in health care price inflation.
The views expressed in this post, and in each of the presentations, are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
About the Authors
Jonathan McCarthy is a vice president in the Federal Reserve Bank of New York's Research and Statistics Group.
Richard Peach is a senior vice president in the Bank's Research and Statistics Group.
Robert Rich is an assistant vice president in the Federal Reserve Bank of New York's Research and Statistics Group.
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