Jonathan McCarthy, Richard Peach, and Simon Potter
We are presenting the New York Fed staff outlook for the U.S. economy to the New York Fed’s Economic Advisory Panel (EAP) at their meeting here today. It is an opportunity we take occasionally to get critical feedback from leading economists in academia and the private sector on the staff forecast; such feedback helps us evaluate the assumptions and reasoning underlying the forecast and the risks to it. Subjecting the staff forecast to such evaluation is important because it is an input assisting New York Fed President William Dudley in his preparation for the monetary policy decisions made at Federal Open Market Committee (FOMC) meetings. In a similar spirit of inviting feedback, we are sharing a short summary of the staff forecast in this post; for more detail, see the material from the EAP meeting on our website.
Staff Forecast Summary
Here we discuss the New York Fed staff forecast for real GDP growth, the unemployment rate, and Consumer Price Index (CPI) inflation in 2012 and 2013.
The staff forecast anticipates moderate economic growth over the next two years. Real GDP growth in 2012 is expected to be around 2.5 percent, close to the average growth rate in 2011:Q4 and 2012:Q1. Although activity in those quarters probably was supported by some transitory factors, including the warm winter in many parts of the country and the rebuilding of motor vehicle inventories, the staff also expects some of the headwinds that have hampered growth in recent years to subside gradually, allowing improved fundamentals to become more apparent in the second half of the year. Fiscal policy is expected to exert a significant drag on GDP growth in 2013, but the expected further lessening of headwinds—especially as the labor market and financial conditions continue to heal—is projected to lead to growth of around 3 percent that year.
With the overall economy improving moderately, the staff projects the unemployment rate to continue to fall over the next two years, averaging about 7.2 percent in the fourth quarter of 2013. Besides the expected path of real GDP growth and productivity growth (which we expect to return to near its long-term trend after weak growth over the past year), the staff forecast for the unemployment rate is influenced by the factors cited in the series of posts on the labor market in the Liberty Street Economics blog (as summarized in the concluding post).
Overall CPI inflation, after being elevated in 2011, is expected to slow notably in 2012 to just over 2 percent, largely reflecting the movements in oil and gasoline prices and the expectations of those prices embedded in futures markets prices. In particular, the recent declines in gasoline prices at a time when they are typically rising suggest a fairly large decline in seasonally adjusted energy prices over the near term. In 2013, the staff expects CPI inflation to be modestly higher as inflation moves toward expectations and the FOMC’s longer-run goal for inflation. (Staff analysis indicates that its 2013 projection of CPI inflation is roughly equivalent to 2 percent inflation as measured by the personal consumption expenditures deflator, the measure followed by the FOMC.) The continued anchoring of longer-term inflation expectations and subdued compensation growth are consistent with inflation remaining near that objective.
Comparison to the Blue Chip Forecasts
Here, we compare the New York Fed staff forecast to the consensus forecast from the May Blue Chip Economic Indicators, which was published on May 10 for a survey conducted on May 2-3.
The staff forecast for real GDP growth is somewhat above the Blue Chip consensus, which probably reflects the fact that the staff expects more receding of the headwinds and greater improvement in fundamentals than in the consensus forecast. For the unemployment rate, the staff forecast is notably below the Blue Chip consensus forecast and near the average of the bottom ten forecasts in that survey. The difference between the staff forecast and the consensus reflects the staff’s higher projected real GDP growth path and its assessment that there remains considerable slack in resource utilization. (The concluding post of our labor market series mentioned earlier provides some estimates of how low the unemployment rate could go.)
Because the latest fall in oil prices occurred after the Blue Chip survey was conducted, the current staff inflation forecast is somewhat below the consensus forecast for 2012. The 2013 staff inflation forecast is slightly above the Blue Chip consensus, as the staff sees a stronger influence on inflation from anchored inflation expectations relative to resource slack than do many private forecasters.
Risks to Staff Forecast
Because modal forecasts are frequently “incorrect” in retrospect, an important part of the staff analysis of the economic outlook is the assessment of the risks to the forecast. In a very uncertain environment, the staff sees the balance of risks to real economic activity as being skewed to the downside. Reasons for this assessment include possible spillovers if the European sovereign debt crisis intensifies, the economic impact from larger-than-expected fiscal restraint, and geopolitical events leading to a renewed surge in oil prices. Because the latter possibility would push up inflation, the staff assesses the near-term inflation risks as roughly balanced, although the medium-term risks are skewed modestly to the downside. For another view on the risks, see the Survey of Professional Forecasters from the Philadelphia Fed (the latest was released today), which provides respondents’ probability assessments for real GDP growth, unemployment, and inflation. Of course, the New York Fed staff monitors developments to see if such risks are beginning to materialize and adjusts its forecast accordingly.
The views expressed in this post, and in each of the presentations, are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.