The Economy: A View from the (Atlanta) Fed (Staff)

The Economy: A View from the (Atlanta) Fed (Staff) 2018 Alabama Economic Outlook Montgomery, AL January 11, 2018

2 The new supply-side economics? In their discussion of monetary policy, participants saw the outlook for economic activity and the labor market as having remained strong or having strengthened since their previous meeting, in part reflecting a modest boost from the expected passage of the tax legislation under consideration.

3 Will the tax cuts continue to matter? Yes, probably but how much? Most participants pointed to changes in tax policy as likely to provide some boost to real GDP growth over the forecast period.

4 The view from the FOMC: Growth holding up then slowing to a relatively slow longer-run pace. 3 Real GDP Growth Percent, Q4/Q4 Actual Projected 2.5 2 1.5 1 2012 2013 2014 2015 2016 2017 2018 2019 2020 Note: The red line is the median projection; shaded bars represent the central tendency range of projections.

Will the tax cuts matter? Survey says: Results from the Business Decision Maker Survey. 5 Decision Maker Survey - (November 13-24) If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures All Responses 1% 65% 15% 18% 1% decrease capital expenditures by 10% or more decrease capital expenditures by less than 10% no material change to capital expenditures increase capital expenditures by less than 10% increase capital expenditures by 10% or more

6 The Business Decision Maker Survey indicates that small business are somewhat more likely to increase capital expenditures as a result of tax reform. Decision Maker Survey - (November 13-24) If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures in 2018? By Firm Size Small Firms (0-99 employees) 2% 1% 54% 20% 22% Midsize Firms (100-499 employees) 1% 1% 73% 9% 16% Large Firms (500 or more employees) 3% 65% 21% 12% Note: Totals may not add to 100 due to rounding decrease capital expenditures by 10% or more decrease capital expenditures by less than 10% no material change to capital expenditures increase capital expenditures by less than 10% increase capital expenditures by 10% or more

7 Across sectors, construction was the only area suggesting significant changes in planned capital expenditures. Decision Maker Survey - (November 13-24) If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures in 2018? By Sector Construction 5% 36% 18% 41% Finance and Insurance 65% 22% 14% Healthcare and Social Assistance 10% 81% 10% Leisure and Hospitality 73% 9% 18% Manufacturing 71% 15% 14% Mining and Utilities 61% 17% 22% Professional and Business Services 3% 3% 73% 8% 14% Retail and Wholesale Trade 61% 19% 19% Transportation and Warehousing 50% 33% 17% Note: Totals may not add to 100 due to rounding decrease capital expenditures by 10% or more decrease capital expenditures by less than 10% no material change to capital expenditures increase capital expenditures by less than 10% increase capital expenditures by 10% or more

8 What about tax reform and hiring plans 80 70 Expected impact of Tax Cuts and Jobs Act on Hiring Plans (by firm size) Small firms (<=100) Larger firms (>100) 68.9 60 50 51.1 40 37.8 30 20 10 0 23.0 10.0 5.4 0.0 1.4 1.1 1.4 decrease significantly decrease somewhat no change increase somewhat increase significantly

9 The new supply-side economics? The [supply-side] theory of the 1980s focused mainly on individuals, and lowering the tax rates they faced on labor income and capital gains... The idea today is that the real power of mobilization comes through corporate associations. Assuming the tax bill passes, that theory is about to get a major test.

The growth effects of the Tax Cuts and Jobs Act (according to the Penn Wharton Budget Model). 0.14 0.12 TCJA Effects on Average Annual Growth Relative to Current Policy Percentage point change Low Estimate High Estimate 0.1 0.08 0.06 0.04 0.02 0 2018 to 2027 2028 to 2040 Source: The Tax Cuts and Job Acts, as Reported by Conference Committee (12/15/17): Static and Dynamic Effects on the 10

The growth effects of the Tax Cuts and Jobs Act (according to the Penn Wharton Budget Model). 0.14 0.12 TCJA Effects on Average Annual Growth Relative to Current Policy Percentage point change Low Estimate High Estimate 0.1 0.08 0.06 0.04 0.02 0 2018 to 2027 2028 to 2040 Source: The Tax Cuts and Job Acts, as Reported by Conference Committee (12/15/17): Static and Dynamic Effects on the 11

data through December 2017 12 Both the narrow (U3) unemployment rate and the broader (U6) underemployment rate suggest that labor utilization is about normal 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 (U6) 2005-2007 average Unemployment (U-3) and Underemployment (U-6) Rates percent Unemployment rate (U3) FOMC participants median unemployment rate estimate (from Dec. 17 SEPs) Un(under)employment rate (U6). Includes PTER and marginally attached workers 05 06 07 08 09 10 11 12 13 14 15 16 17

13 Historical estimates of normal unemployment, from the Congressional Budget Office. 12 10 8 6 4 2 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

14 Normal unemployment rates are not really all that normal 12 10 8 6 4 2 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

15 but there have been relatively few high pressure episodes in recent history. 12 10 8 1964:Q3 1971:Q4 1978:Q2 1987:Q3 1997:Q1 2005:Q4 6 4 2 High pressure periods, where the unemployment rate falls below its natural rate. 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

16 Historically, high pressure periods have not ended well. 12 High pressure periods. 10 8 1964:Q3 1971:Q4 1978:Q2 1987:Q3 1997:Q1 2005:Q4 6 4 2 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

17 Beware the spurious correlation: Case study 1 Source: http://www.tylervigen.com/spurious-correlations

18 Beware the spurious correlation: Case study 2 Source: http://www.tylervigen.com/spurious-correlations

Worth noting: Historically, expansions have also ended (and inflation has risen) when oil prices spike. dollars per barrel Real Oil Prices West Texas Intermediate 60 50 40 30 20 10 0 60 65 70 75 80 85 90 95 00 05 10 15 Note: Real oil prices calculated in 1982-1984 dollars using the consumer price index Source: Bureau of Labor Statistics; Energy Information Administration; Haver Analytics 19

20 Another relevant picture? The term structure of interest rates 4 10 Year / 2 year Treasury Note Spread percent 5 3 4.5 4 2 3.5 1 0 3 2.5 2-1 1.5-2 1 0.5-3 1984 1988 1992 1996 2000 2004 2008 2012 2016 0

21 Could monetary policy overdo it? Meeting participants also discussed the recent narrowing of the gap between the yields on long- and short-maturity nominal Treasury securities, which had resulted in a flatter profile of the term structure of interest rates Some expressed concern that a possible future inversion of the yield curve, with short-term yields rising above those on longer-term Treasury securities, could portend an economic slowdown

Sources: Bureau of Economic Analysis; Dallas Fed; Haver Analytics data through November 2017 22 Trend measures of inflation are still running soft relative to the FOMC s 2% longer-run target. 3.0 2.5 Core PCE FRBD trimmed-mean PCE PCE Price Index year-over-year percent change, monthly 2.0 FOMC s inflation target 1.5 1.0 0.5 0.0 10 11 12 13 14 15 16 17

Our explanation for low inflation: Stuff happens Source: Janet Yellen, Inflation, Uncertainty, and Monetary Policy Speech to the Annual Meeting of the National Association of Business Economists, 23

Sources: Bureau of Economic Analysis; FRB Dallas; Haver Analytics 24 A concern: If the inflation goal was 1.75 percent, the inflation rate of the past 5 years would look just about right. 4.0 3.5 3.0 PCE Price Index year-over-year percent change, monthly 2.5 2.0 FOMC s inflation target 1.5 1.0 Hypothetical 1.75 percent target 0.5 0.0-0.5 10 11 12 13 14 15 16 17

Source: Atlanta Fed Business Inflation Expectations (BIE) Survey, April 2017 25 Our survey indicates many businesses believe the Fed is most worried about inflation rising above 2%. Firms' Perception of Federal Reserve's Tolerance for Inflation Above/Below its Inflation Target percentage of responses 40% 35% 38% 30% 25% 22% 25% 20% 15% 15% 10% 5% 0% more likely to accept inflation above its inflation target more likely to accept inflation below its inflation target equally likely to accept inflation above or below its inflation target Unsure

26 You gotta have faith The SEP projections bring us to the inflation target by 2019. 2.5 Real GDP Growth Percent, Q4/Q4 Actual Projected 2 2% Longer-Run Objective 1.5 1 2012 2013 2014 2015 2016 2017 2018 2019 2020 Note: The red line is the median projection; shaded bars represent the central tendency range of projections.

27 The watch list Will the tax reform stimulus be bigger than we think? Will longer-term interest rates stall or take off? Will inflation be too cold, too hot, or just right?

The Economy: A view from the (Atlanta) Fed (Staff)