The Washington PostDemocracy Dies in Darkness

Head winds and tail winds: Assessing the current economy

(Patrick T. Fallon/Bloomberg News)

The nation’s economic expansion is just about eight years old, making it the third longest on record. Unemployment is a low 4.5 percent. Payrolls have been reliably adding jobs almost every month since late 2010. And finally, in 2015, wage growth started reaching more workers, which is probably one reason consumer sentiment on the economy has jumped in recent months.

But if you get under the hood, the economic engine is not quite firing on all cylinders. There’s nothing too untoward, and some of the less-flattering indicators are too new to be trends. No one’s saying the r-word, and remember: Expansions don’t die of old age. But they do die, and while the only accurate thing economists can tell you is that we’re one day closer to the next recession, we can offer some perspective on the big picture.

Indicators of concern include:

  • There have been two consecutive monthly declines in retail sales, and last month’s consumer price index fell, a sign of weak consumer spending — if it sticks.
  • The March jobs number came in low (but these monthly data are noisy); wage growth for blue-collar workers, which was handily beating inflation a year ago, is no longer doing so (this one is particularly important).
  • Employment rates of working-age people are still not back to pre-recession peaks, though they’re getting there.
  • Some estimates for first-quarter GDP growth are below 1 percent, though first-quarter GDP data have been biased down lately.
  • Bank loans have slowed; the S&P 500 is down about 2 percent off its March high; the dollar has been ticking down; bond yields have fallen back to their mid-November levels, as expectations of Trump-induced growth and price pressures have faded. Market skittishness has the volatility index up 24 percent this month.

As all those caveats suggest, none of these indicators is particularly alarming, yet. Financial markets get a lot of credit for being forward-looking, but they clearly leaned too far over their skis with this notion that Trump was going to unleash all kinds of growth through tax cuts, deregulation and an amazing, $1 trillion infrastructure program. He’s got no plan, no coalition, no policy bench, and every day brings a new lurch.

Isn’t that, in and of itself, a big problem for the economy? Not necessarily. While a real infrastructure plan would be useful on many levels, I welcome the administration’s failure to raise tariffs, repeal the Affordable Care Act and, at least thus far, pass a big, wasteful tax cut.

Why some families who save constantly are still struggling to make ends meet

It’s hard to turn away from the cray-cray at 1600 Pennsylvania Ave., but the best place to look for hints about near-term economic conditions is the good old job market. Most working-age people depend on their paychecks, not their portfolios, and healthy job and wage growth fuels healthy consumer spending, which amounts to 70 percent of U.S. GDP.

In other words, for all the complexities in today’s global economy, and they are legion, the virtuous cycle is simple: working people earning, spending and investing to meet their families’ needs and wants, while in the process generating more demand that must be met by more production. (If that sounds environmentally rash, consider that our needs and wants should and often do include sustainable energy.)

The figure below shows the correlation between aggregate weekly earnings (jobs × real wages × average weekly hours worked) and consumer spending (year-over-year percent changes in both variables). The two are highly correlated, and with a slightly souped-up model (using just unemployment and aggregate earnings), I can explain 85 percent of the variation in the growth of real consumer spending. If things stay about where they are, the model predicts that consumer spending will tick down from around 3 percent to around 2 percent to 2.5 percent per year.

The decline is largely a function of higher inflation leading to a downshift in the real growth of blue-collar wages, with slightly slower job growth also in the mix.

Remember: That spending growth number gets a 70 percent weight in GDP, so unless some other part of the economy — investment, government spending, net trade — picks up the slack, growth could slow from where it is, which is already moderate.

The model leaves out a lot of factors, including credit availability (it’s tightening), any wealth effect from the stock market, and the Federal Reserve’s campaign to hike interest rates. All of those are head winds for consumer spending.

As for tail winds, I expect that as we close in on full employment, blue-collar pay should accelerate, which will boost consumer spending. So this ain’t over, as long as the job market continues to tighten up. By the way, if inflation really has weakened — one month doesn’t make a new trend — that should prompt the Fed to pause in their rate-hiking, a move that would be consistent with this analysis.

So, watch the job market and the real wages of regular workers. My guess is that those variables will be — far more than Trumpian flip-flops on Chinese currency and NATO — not just economically but politically determinative.