Jan 18, 2016 - 10:00am

Headwinds on the Horizon

Former Chief Economist, U.S. Chamber of Commerce

Former Senior Vice President, Economic Policy Division, and Former Chief Economist

Former Senior Economist

The U.S. economy racked up another middling performance in 2015. Personal consumption expenditures and residential investment performed a bit better than in 2014, but most GDP components underperformed again. Since the end of the recession the economy has grown just 2.2% annually, registering the weakest expansion in the modern era.

Real GDP slowed to a 2.0% pace in the third quarter after growing 3.9% in the second quarter. Expectations for the fourth quarter have dampened further, suggestingthat overall 2015 growth will essentially repeat 2014’s 2.4% and further suggesting little momentum into the new year.

The outlook for 2016 is subdued and cautious, with risks outnumbering areas of optimism. A recession’s near-term odds remain low, but a slowdown from 2015’s disappointing result remains a distinct possibility.

Consumption. Personal consumption expenditures rose 3.0% in the third quarter after rising 3.6% in the second quarter. Of particular note, auto sales maintained momentum in 2015 with sales hitting nearly 17.5 million units, a strong 6% bump from 2014.

Slight improvements in real wages and household wealth, coupled with moderately strong job growth, indicate continued moderate 2016 consumption growth. While financial markets were flat in 2015 and began 2016 on a weak note, housing prices continue to improve slowly.

Investment. Business investment slowed over the past few quarters due in part to headwinds from declining energy sector investment

but also due to the effects of a strong dollar exchange rate. Business investment grew about half as fast in 2015 (approximately 3.2%) as in 2014. Investment may be slightly stronger in 2016, but the pace likely won’t exceed 3.5%. Several reasons inform this more temperate outlook.

On the positive side, domestic consumption growth could lead to more business investment, but this positive is perhaps more than offset by the anticipated outpouring of government regulations as President Obama’s tenure comes to a close.

Moderately positive business confidence in the manufacturing sector prevailed early in 2015 but declined as the year progressed. By year-end, growth in manufacturing had essentially halted. And credit constraints remain binding for many firms—particularly for some small businesses.

Industrial production—including manufacturing, mining, and utility output—remains weak, and capacity utilization remains 3.1 percentage points below its long-run average. These results are exceptional and disappointing this far into an expansion.

Should the opportunity for a surge in domestic business investment arise, firms should have no difficulty financing this investment. Financing is not the primary restraint limiting business investment. The primary restraint is need—there is sufficient excess capacity to support future demand if it materializes.

Trade. Further complicating the forecast is our net trade position. Export growth slowed in the third quarter to only 0.7%, much slower than import growth at 2.3%. Both were influenced by the strong dollar exchange rate. Beginning in 2011, the dollar strengthened gradually against our major trading partners’ currencies. This process accelerated in the second half of 2014 and continued at a more moderate pace in 2015. The dollar’s rise will tend to worsen the U.S. net trade position through 2016.

Another key determinant of our trade balance is the economic health of our trading partners. Many countries such as the U.K., India, and Malaysia continue to perform well, but economic weakness elsewhere is widespread and may be spreading. At one extreme, Venezuela’s rapidly contracting economy in the face of extremely high inflation is widely echoed to one extent or another across South America. Russia may also be in this category, though for different reasons.

Europe’s 2015 growth was positive but weak, and several countries teeter on recession. The Eurozone risks deflation and a Greece-driven currency crisis, all of which threaten to erase Europe’s forecast for tepid 2016 growth.

Japan’s economy has once again slowed to a crawl, but deflation has been arrested. Moreover, Japan appears to have largely exhausted its macroeconomic tools to reignite its economy.

China’s slowdown presents a new concern. Official statistics notwithstanding, the overall economy appears to have slowed markedly, with manufacturing hit especially hard. Also, the yuan is under strong downward pressures owing in part to domestic capital flight, forcing the central bank to expend enormous amounts of its reserves defending the currency. A persistent slowdown in China would be especially problematic for Europe, although the United States would also be affected.

All in all, foreign demand is unlikely to provide much support for U.S. export growth in the near future.

The Labor Market. Perhaps the most optimistic indicator of economic improvement at home appears in the labor market data. Payroll employment increased 292,000 in December and by 284,000 on average over the past three months.

In 2015, the labor market added just 2.7 million net new jobs, slower than the
3.1 million created in 2014. For 2016, private forecasters project payroll employment to slow more to around 2.2 million (185,000 per month).

The unemployment rate was unchanged at 5.0% in December, and the underemployment rate was unchanged at 9.9%. Much of the improvement on this front—the unemployment rate was 5.7% in January 2015—results from continued declines in the civilian labor force participation rate, which is at a four-decade low.

Real wage gains have been scarce for much of the recovery. Real wages improved modestly over 2015, but some gain is better than none. As labor markets continue to improve slowly, stronger real wage growth should eventually materialize. However, productivity growth, which has lagged markedly throughout the recovery, will have to improve before strong, sustained wage growth can take hold.

Monetary Policy. The Federal Reserve continues to normalize monetary policy. The Fed concluded quantitative easing when it halted purchases of securities in 2014, but it has not started to reduce its asset holdings.

In December, the Fed increased the funds rate by 0.25%. According to guidance, the funds rate should increase roughly once per quarter for the next two to three years. Monetary policy is becoming less supportive of economic growth but is not yet restraining the economy. As long as inflation remains subdued, actual restraint is unlikely until perhaps 2018.

Downside Risks. Since the end of the recession, growth has been at a subpar pace, with no indication yet of breaking out of this languor. On balance, 2016 will likely look a lot like 2015, but shifts in the global economy combined with poor policies at home mean downside risks shadow the forecast.

The greatest near-term threats to the U.S. economy arise abroad. Provided these threats do not trigger a severe financial crisis, the effects will be felt most in terms of U.S. export potential.

The only clear and material domestic imminent threat involves the widely anticipated surge of regulations issued by the Obama administration in its last year in office. The administration’s regulatory outpouring to date is largely responsible for the economy’s subpar performance. Any acceleration in new regulations could easily result in a deacceleration in economic growth.

To perform up to its potential, this economy needs policies reducing the regulatory burden. It needs comprehensive tax reform to improve overall economic efficiency by allowing individuals and businesses to make decisions free of tax distortions. It needs the efficiency gains made possible by continual efforts to reduce trade barriers. In short, it needs government to pursue policies that remove government from the job-creating private sector’s way.


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About the Authors

About the Author

Former Chief Economist, U.S. Chamber of Commerce

Dr. Martin A. Regalia was senior vice president for economic and tax policy and chief economist at the U.S. Chamber of Commerce until his retirement in 2016.

About the Author

Former Senior Vice President, Economic Policy Division, and Former Chief Economist

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.

About the Author

Former Senior Economist

Brian Higginbotham is former senior economist at the U.S. Chamber of Commerce.