Wednesday, June 19, 2024

Recent reports indicate lower growth is bigger risk than higher prices

Wanted to forward you to a couple of good posts by UW-Madison's Menzie Chinn at Econbrowser going over recent reports on the economy.

The first puts together a number of recent indicators, and gives us a mixed bag. Industrial production had a surprising increase, and finally got back to the levels we were at in Spring 2023. The payrolls numbers keep rising, but the household survey hasn't changed much at all. In addition, inflation-adjusted consumption, incomes, and sales at the wholesale level have been largely flat in the first half of 2024.

In addition, we saw retail sales for May be disappointing, with only a minor rise of 0.1%, and April's retail sales numbers were revised down to a 0.2% (seasonally adjusted) loss. Combine that with the flat inflation numbers for May, and it's more evidence to me that we have downshifted from the higher inflation of 2022-2023, and likely have also see the Biden Boom of 2021 through 2023 also cool off into a post-COVID normality.

The other post of Professor Chinn's that I want to point you toward is one that discusses the recent economic outlook released by the Congressional Budget Office.
The CBO projections are based on data available as of May 2nd. The latest CBO projection is substantially above the February projection (see discussion here), largely due to the intervening upside GDP surprises. It’s currently in line with the FT-Booth June median forecast, and the slightly below (for Q2) the Atlanta Fed nowcast. (It’s slightly above the May median Survey of Professional Forecasters estimate).

While the revised q/q growth rate projections are higher in the short term, relative to February forecast (based on data available as of January 6), then decelerate to slower rates by end 2025, implying reversion to potential. That being said, the current implicit CBO projection of the output gap is dramatically different than reported in the February Economic Outlook....

This means the CBO is projecting a positive output gap for the next year and half, under current law. For perspective, the pre-pandemic peak output gap was 0.9 ppts, while the highest in recent history is 2.4% in 2000Q2.

But that also means America's economy has been exceeding its potential in the last year, and inflation has settled into a 3% annual rate for the better part of the last year, and indications that it will fall further in the coming months. It tells me that our bigger concern should be that things slow further and we run a risk of recession, and not worry about whether inflation is 2% or 3%.

And it's all the more reason for the Federal Reserve to start lowering interest rates from these 23-year highs. Instead, Chinn says the CBO now predicts there won't be rate cuts until early next year.

That better not be true. If so, it makes me all the more suspicious that the Fed doesn't really understand what things are like for the typical American, and that they are still trapped in 1970s thinking in a 2024 reality.

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