Jonathan McCarthy and Richard Peach
Today, the Federal Reserve Bank of New York (FRBNY) is hosting the spring meeting of its Economic Advisory Panel (EAP). At this meeting, FRBNY staff are presenting their forecast for U.S. growth, inflation, and unemployment through the end of 2015. Following the presentation, members of the EAP, all of whom are leading economists in academia and the private sector, are asked to critique the staff forecast. Such feedback helps the staff evaluate the assumptions and reasoning underlying their forecast and the key risks to it. Subjecting the staff forecast to periodic evaluation is an important part of the forecasting process; this review informs the staff’s discussions with New York Fed President William Dudley about economic conditions. In the same 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 inflation in 2014 and 2015.
From the end of the Great Recession in mid-2009 through mid-2013, the U.S. economy grew at a compound annual rate of 2.2 percent. Then, over the second half of 2013 growth picked up to 3.4 percent (annual rate), reflecting stronger growth of real personal consumption expenditures (PCE), business fixed investment, exports, and inventories. However, in the first quarter of 2014, real GDP was essentially unchanged. The growth contributions from inventories and net exports, which had been positive over the second half of last year, were negative in the first quarter, which was widely anticipated. But in addition, severe winter weather had a significant depressing effect on economic activity, particularly in January and February.
Despite the slow start in the first quarter, the staff forecast anticipates economic growth of around 3 percent (annual rate) over the remainder of 2014, with some additional strengthening to around 3½ percent in 2015. Several key underlying fundamentals of the economy have improved, setting the stage for a firming of growth. Household wealth has been restored, and the deleveraging process is largely over. For the first time since 2008, we are beginning to see growth of total household liabilities. The excess supply of housing has been largely worked off, and home prices have risen more than expected, contributing to higher household wealth. Fiscal restraint at the federal and the state and local levels of government now is, for the most part, behind us. And growth prospects among our major trading partners look somewhat better, particularly in the euro area.
It should be noted, however, that the growth rate anticipated in the forecast is still not as robust as experienced in previous expansions. The recovery of residential investment is likely to continue to be relatively muted, reflecting continued tight mortgage underwriting standards. Similarly, growth of business fixed investment is expected to be only moderate until capacity constraints become binding.
With the economy expected to grow somewhat faster going forward, the staff forecast anticipates somewhat stronger employment growth. From an average of around 190,000 per month from 2013:Q2 through 2014:Q1, average monthly gains of nonfarm payroll employment should move up to around 225,000 over the remainder of 2014, and then advance to around 275,000 in 2015. This presumes growth of productivity in the nonfarm business sector of around 1½ percent (1¼ percent on a GDP basis)—the rate that the staff assumes to be the current trend. With stronger employment growth, the unemployment rate is expected to decline to about 6 percent by the end of 2014, and then to between 5¼ percent and 5½ percent by the end of 2015. This projection anticipates that, as the labor market improves, the labor force participation rate will bottom out in the near future and then rise to 63.4 percent by the end of 2015.
Inflation continued to slow over the past year, with the four-quarter change of the total PCE deflator at 1.1 percent as of 2014:Q1, down from a recent high of 2.0 percent in 2012:Q1. The staff forecast anticipates that inflation will rise to 1.6 percent by the end of 2014 and to 1.8 percent by the end of 2015. As the amount of slack in the U.S. economy gradually subsides, putting less downward pressure on inflation, the gravitational force of well-anchored inflation expectations will slowly pull the inflation rate back up toward the FOMC’s longer-run goal for inflation of 2 percent. Current futures prices suggest that oil prices will be trending lower over this forecast horizon, such that total and core inflation rates in 2015 are likely to be essentially equal.
Comparison to the Blue Chip and SPF Forecasts
Here, we compare the New York Fed staff forecast to the consensus forecast from the May Blue Chip Economic Indicators, published on May 10, and the first-quarter Survey of Professional Forecasters (SPF), published on February 14. [Note: the second quarter SPF is being released today (May 16).]
The staff forecast for real GDP growth in 2014 is similar to the Blue Chip consensus forecast and the SPF median forecast. Most forecasts anticipate some firming of growth in 2014 as fiscal restraint subsides and consumer spending strengthens in response to increased wealth and confidence and some easing of lending standards. However, for 2015, the staff forecast anticipates somewhat stronger growth of real GDP than either the Blue Chip or SPF. This difference appears to stem mainly from the fact that the staff forecast anticipates that business fixed investment will begin to provide a more substantial impetus to growth. The resulting strengthening in job and income growth then results in some additional firming of consumer spending. This stronger growth in 2015 influences the relative performance of both inflation and the unemployment rate. The staff forecast foresees somewhat faster inflation in 2015 than the Blue Chip or SPF forecasts as well as a somewhat lower path for the unemployment rate.
Risks to Staff Forecast
An important part of the staff analysis of the economic outlook is the assessment of the risks to the forecast. For 2014 the staff sees the risks to real economic activity as skewed somewhat to the upside, while for 2015 the risks are roughly balanced. The key upside risk is that after several years over which investment in consumer durable goods, housing, and business fixed investment has been relatively sluggish, the improvement in underlying fundamentals could spark a more pronounced increase in risk appetite and thus stronger spending in these categories. The key downside risks are that global demand turns out to be weaker than expected or that financial conditions tighten unexpectedly.
For inflation, the staff concludes that the risks are roughly balanced in both 2014 and 2015. The key upside risks are that either or both the level and growth rate of potential GDP are lower than believed. In addition, inflation expectations could become unanchored on the upside if monetary policy were to remain too accommodative for too long a period. In the other direction, the downside risk to growth would result in greater slack for a longer period, leading to lower inflation and possibly a downside breakout in inflation expectations. This would be even more likely if global disinflation forces turn out to be stronger than expected.
The views expressed in this post 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.
Jonathan McCarthy is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.
Richard Peach is a senior vice president in the Bank’s Research and Statistics Group.