Cutting tariffs is better than cutting payroll taxes to boost the economy
The economic expansion seems to have reached the bottom of the ninth—but are we headed to extra innings?
In some ways watching the economy is like watching a baseball game: It's riveting (for some of us) and there are countless statistics that hint at the likely outcome. But it's difficult to predict; unlucky bounces can substantially alter the situation, and you never know which players might unexpectedly rise to the occasion. Maybe that's why a lot of macroeconomists are also baseball fans. I'm one.
The U.S. economy is doing reasonably well, at the moment. It grew at a little more than a 3 percent annual pace in the first quarter, and the second quarter's pace looks to be about 2 percent. If our forecast is in the ballpark, full-year 2019 should register between 2 percent and 2.5 percent growth in gross domestic product (the value of all the goods and services produced in the economy).
Positive GDP growth suggests that the economy will keep adding jobs, though possibly at a slower pace. The Labor Department issues a release on the first Friday of every month with myriad statistics measuring labor market conditions. Growth in nonfarm employment generally gets top billing, with the unemployment rate coming in a close second.
The Fannie Mae Economic and Strategic Research Group thinks that job growth will average around 150,000 per month through the rest of the year, reflecting a modest slowing of economic growth, and the unemployment rate will average 3.7 percent for the year, near its historic low.
Recently, when the employment figures for June came in stronger than expected, the stock market fell. On its face, this seems counterintuitive: Wouldn't a strong report suggest that the economy was performing well, and wouldn't that increase company values?
Put simply, yes. But it also meant, to stock market participants, that the Federal Reserve was less likely to cut interest rates-or at least less likely to cut them as much as market participants were expecting. Instead of a double cut of 50 basis points (a basis point is 1/100th of a percentage point) in July, I and many others now believe that the Fed will deliver only a single cut of 25 basis points.
Beyond GDP and employment, economists also pay close attention to business fixed investment, consumption and trade. Businesses invest when they are confident that future sales will grow, as investing enables them to improve production. This year, though, we expect the pace of business investment to be weak at just 1.8 percent annualized, despite the recent favorable changes to the corporate tax code. In our view, the main reason for the potential slowdown in investment is uncertainty, much of which is the product of the rancorous, on-again/off-again trade negotiations with China, as well as tense discussions with other major trading partners.
Businesses can manage risk, but not uncertainty: Increased uncertainty nearly always leads to less investment. Using the baseball analogy, a pitcher studying statistics on opposing batters can leverage them to choose the right pitch in a given situation. That doesn't mean the pitch will always succeed, but at least the risk can be managed. But what if the next batter is a rookie with few performance stats? If there's not enough data to make an informed decision - if the best pitch selection is uncertain - then the pitcher is likely to take a more conservative course of action.
For the Fed's purposes, trade is the rookie. After more than 40 years of continually increasing trade liberalization, businesses now face a climate in which new tariffs are being imposed and new barriers erected. That climate introduces substantially more uncertainty into business planning, prompting businesses to be more conservative and delay new investments.
Taking it a step further: Reduced investment slows productivity gains, which are critical to increasing workers' wages. In the current expansion, productivity gains have been frustratingly weak (though there has been some recent evidence of improvement).
Incomes have been rising, but the pace of income growth has only recently recovered to its long-term average. An important measure is average hourly earnings for all private nonfarm payroll employees, which the latest report shows increased 3.1 percent over the past 12 months. Importantly, income growth has picked up among lower income households, which supports further business production while also improving household financial security.
Income growth is critical to consumer spending. The Census Bureau reported this past Tuesday that consumers are indeed spending some of their increased wages, with June retail sales up 3.4 percent over the past year. This is a good sign and supports our economic forecast, which suggests that the continuation of U.S. economic growth will likely be heavily dependent on consumers. It's important to note, though, that uncertainty can affect consumer spending just as it affects business investment.
It may be stretching the analogy, but you might imagine the Fed as the general manager. By selecting an interest rate target, they're setting the team's payroll and crucially affecting its performance. Fed governors have signaled that they intend to reduce short-term interest rates by 25 basis points in late July. Interest rates are effectively the cost of borrowing, and by lowering the cost of credit they hope to increase both business investment and personal consumption. They have noted that their actions are likely to be influenced by trade-related increases in uncertainty and the adverse impact that waning investment may have on the pace of economic growth.
At 10 years old, the current U.S. expansion is officially the longest in U.S. history, but that doesn't necessarily mean it'll end anytime soon. A normal baseball game is nine innings, but earlier this year my favorite team, the Twins, played a game that lasted 18 innings and ended only after a batter with less than a full season under his belt got the better of my team's pitcher.
Consider this: The longest Major League Baseball game lasted 26 innings, but Australia's current economic expansion has already passed 27 years. The lesson? This expansion, even in its tenth year, can keep going, especially if increased certainty gives businesses the confidence to deliver the best pitch.
Doug Duncan is senior vice president and chief economist at Fannie Mae.