A good economic forecaster is one who can convincingly explain why her forecasts are wrong, which is to say: Such forecasts should be ingested with lots of salt. With that caveat in mind, here are six predictions about key outcomes this year. To be more upfront about my confidence or lack thereof in each guesstimate, I’ve added my totally subjective percent likelihood for each one.
The federal deficit is going up (90%). This one’s a pretty sure bet, given the extent to which (a) most government spending for the year is already “baked in the cake,” and (b) President Trump’s tax cut broke the historical positive linkage between strong macroeconomics and revenue flows to the Treasury Department. The Congressional Budget Office predicts a deficit of 4.6 percent of gross domestic product in 2019 (just under $1 trillion), up from 3.8 percent this year. Historically, when unemployment has been as low as it is (and I expect it to fall further this year), the deficit-GDP ratio has been close to zero.
One key development to watch here is how Congress handles the potential “spending snapback,” i.e., the return of budget caps in 2020. My forecast is that they again override them (as they should, to avoid a too-negative fiscal impulse), but this will be fodder for yet another budget fight later this year. I know — can’t wait.
Economic growth will slow (75%). Regular readers of this column know that I try not to overweight GDP growth in my analysis, as there’s just a ton it leaves out. But if I’m right about this prediction — and it’s by far the standard forecast — it could be a big deal. The main head wind we expect to slow growth is the fading of fiscal stimulus later this year. Deficit-financed tax cuts and spending added about a point to the 2018 growth rate. Unless Congress adds a lot more to the deficit than expected (since the expected part is already built into the forecasts), the fiscal fade will give up that point by the second half of the year, and we’ll divert back to the trend growth rate of around 2 percent (though at least one credible forecast is for 1 percent).
Hey, at least that’s not a recession, right? What’s the big deal?
First, it’s a signal that, as expected, the tax cut didn’t lift the trend growth rate the way its advocates claimed it would. Instead, the 3 percent growth rate of 2018 was a sugar high from stimulating an economy already closing in on full employment.
Second, the political implications of slower growth could be huge. Even at his craziest, Trump could point to the above-trend growth rate and historically low unemployment rate, essentially challenging critics with, “If I’m so nuts, why’s the economy doing so well?” The truth is more complicated, of course, but what happens when the economy no longer underpins his substantively paper-thin regime?
Job creation tends to lag behind the rest of the economy, and I expect slower but still robust job growth to persist for a while, so these dynamics may not be observable until later this year. But I’m pretty sure they’re out there.
The Fed will pause, but it won’t stop raising interest rates (65%). Given the slower growth forecast, along with tighter financial conditions (higher interest rates, the decline in equity values), weakness in housing and autos, and thus far tame inflation, the Federal Reserve is likely to slow its rate hike campaign. Instead of raising rates a quarter-percent every quarter or so, it might raise them half that much in 2019.
What I don’t find plausible is the forecast by financial markets that the Fed won’t raise rates at all this year. As it stands, unemployment (at 3.7 percent) is close to a percentage point below the Fed’s estimate of the lowest unemployment rate the central bank believes to be consistent with stable prices (4.4 percent). The Fed’s not raising at all this year, especially if unemployment falls further, would be to throw its forecast and economic model out the window. Whether you or I think that such defenestration is warranted is irrelevant. It’s what the Fed thinks that matters, and it still roughly believes its model.
Wages and inflation will both rise, but wages will rise faster (60%). It took a while, but low unemployment is now reliably lifting nominal wage growth. A few years ago, it was stuck at 1.5 percent, year-over-year; now, it’s around 3 percent. But the key forecast here is for lower top-line inflation and thus for faster real wage growth. As I’ve documented, near-term, real wage gains are especially closely tied to oil and gas prices these days. Because energy costs have fallen so much, and I expect them to stay pretty low, I suspect we’ll see real wages for mid-wage workers growing around 1 percent to 1.5 percent, at least in the first half of the year — surely a welcome development.
The trade war will escalate (50%). Will Trump’s tariff rate on a $200 billion subset of imports from China rise as planned from 10 percent to 25 percent in early March? I’ve got this as a coin flip. I believe the administration would like to go there, but if the economy is looking softer than expected by then, they could decide not to. If that happens, look for markets and investors to breathe a real sigh of relief, which yields an insight into Trumpian policy strategy: Create needless chaos so that when you cease the cray-cray, everyone applauds.
Trump fatigue will set in, and the media will turn away from the worst of it (35%). I just find it hard to believe that the media — mainstream and social — can remain so focused on this reality-show presidency. But as you see from my relatively low probability, I admit that this one is wishful thinking.