Almost every economist and commentator who’s weighed in on this, myself included, has stressed anomalies in the quarter, including unusually cold weather, the now-ended West Coast port dispute, and just the measurement error that finds its way into these “high frequency” (comparisons over short time periods) statistics. I like to smooth out such bips and bops by looking at the year-over-year change in the data, and that gets you a healthy 2.9 percent growth rate.
There are, however, two negatives in the report that are not temporary or measurement anomalies; both are big deals and what’s more, they’re related: the strong dollar and weak inflation.
For a number of reasons, including the facts that our economy is growing faster than most of those in Europe and that our Fed is planning to raise interest rates, the dollar is up about 17 percent over the past year relative to the currencies of our trading partners. That makes our exports more expensive for them and their imports cheaper for us. Over the past two quarters, this dynamic increased the trade deficit, which in turn shaved an average 1.5 percentage points of off GDP growth.
That’s big, but exchange rates move around and the dollar trade index has plateaued over the past few months, so perhaps we’ll see some improvement here in coming quarters. (As an aside, this is why I wanted anti-currency manipulation rules in the TPP trade deal — not that the current episode is a function of manipulation by our trading partners; but it’s a clear example of the impact of exchange rates on growth. Alas … I lost that argument.)
But the figure above reveals a much more persistent concern: weak inflation. It plots the yearly growth rate of the consumer inflation measure favored by the Fed, which leaves out volatile oil and food prices. Your inner consumer is probably saying, “dude, what’s the problem with low inflation?!” which translates into cheaper goods and more buying power out of that raggedy old paycheck.
But I’d encourage your inner macroeconomist to worry about the fact that low inflation signals weak demand, particularly through investment and de-leveraging channels. The real rate of interest is the nominal rate minus the inflation rate, so when inflation is this low, the real interest rate can be too high to encourage firms to invest in the future. Second, inflation helps erode nominal debt burdens, so it takes longer for indebted households to come out from under their debts and rejoin the rest of us in the ongoing recovery.
Anyway, those are some reasons why the Fed targets not zero inflation, but 2 percent inflation, which you see drawn in the figure above. And as you can also see, they’ve consistently missed the target.
So why, you ask, are they talking at all about raising interest rates, which would, as discussed above, slow down the economy? It’s an excellent question for which there is no great answer. They’ve held rates at zero for years now and numerous voices are pushing them to raise, in some cases based on the unfounded fear that faster inflation is right around the next corner, waiting to pounce (though you see that neither in the actual data nor the expectations data).
I wonder if they’re just thinking: “There’s another recession out there somewhere, and if we don’t start raising rates, when it hits we’re not going to have much of a perch from which to lower rates again.”
Also, their plan appears to be to just lift rates up a little bit, like a quarter point, so while such a move may not indicated by the data in the figure, at least it’s not likely to do much damage. That’s important, because there’s still considerable slack in the job market, and a lot of people will correctly tell you this recovery hasn’t sufficiently reached them.
Finally, here’s the other thing, tying these two headwinds together. There’s another problem with this preemptive rate hike: higher interest rates strengthen the dollar. So that too pushes the wrong way, though again, just by a little bit.
At any rate, the good news is that real GDP for the second quarter is tracking at 2 percent and rising, and if that sticks, it will confirm our strong suspicions that the flat Q1 reading was a negative outlier. But — and I’m sorry to be that guy (you know, the downer economist) — just because we’re doing better than this -0.2 percent growth rate suggests doesn’t mean we’re doing great. And the Fed, of all “people,” needs to be mindful of that reality.