Transmutation, the Fiscal Balance, Creeping Dots and Stanley Smith Stevens
The Biden Administration’s goal of a $1.9 trillion fiscal stimulus package, sandwiched between the $900 billion package at the end of last year and more to come for infrastructure spending later this year, represents a significant upside risk to U.S. economic growth. Massive fiscal stimulus, in the presence of very low interest rates and a huge amount of pent-up demand may prove to be a combustible mix, heating up the economy quickly, lifting prices and putting pressure on the Federal Reserve to maintain its inflation-fighting bona fides.
In our February U.S. forecast, we show inflation warming up this year. Commodity markets have already tightened. The growth rates of wages and salaries still appear to be trending up for many industries despite, or perhaps because of, the challenges of the coronavirus pandemic. The value of the dollar has declined, putting pressure on import prices. Slack demand has allowed capacity to fall for many industries. Increasing demand in capacity-constrained businesses may result in higher prices.
The Fed has told us in their most recent policy review that they will be slower to lift-off from the zero lower bound of the fed funds rate in this expansion cycle. After lift-off, they will let the economy run hotter. How much slower and how much hotter are key questions answered by the intentionally vague “somewhat” and “a little.” We believe that there is a reasonable chance that the inflation fighting resolve of the Fed will be tested by stronger-than-expected price gains this year and next. We will be watching the Fed’s dot plot to see how their collective and individual assessments of the likely path of the fed funds rate change. New dot plots are expected to be released on March 17th, June 16th, September 22nd and December 15th this year. The December 2020 dot plot showed a nearly unanimous 16 dots at the zero lower bound for the fed funds rate at the end of 2022, with one dot showing lift-off. The pattern for the end of 2023 shows the strong majority of 10 dots still at the zero lower bound and 6 dots showing lift-off. We will be watching the dots this year to see if more creep up in 2022 and 2023, indicating that interest rate lift-off is getting closer.
A balanced economic outlook accounts for both upside and downside risks. A key near-term downside risk is that the Biden Administration does not get the fiscal policy lift that it is asking for. Congress may balk at the substantial price tags for economic relief and infrastructure programs. Money may be spent out differently than anticipated with a higher-than-expected propensity to save or pay down debt.
Concerns in Congress about ballooning federal debt loads are valid, sobering and frustratingly unanswerable. The fear of not doing enough must be balanced with the fear of doing too much on an imperfect scale. Stanley Smith Stevens told us that there are four ways that data is measured. Nominal data falls into categories. Ordinal data can be ranked. Interval data can show measurable differences. Ratio data shows the precise relationship to a benchmark. The question of how much federal debt is too much begs for a precise answer with ratio data, but must suffice with an answer in categories, rankings and intervals, with macroeconomic models providing imprecise indications of potential intervals between one policy choice and another. We will not have the luxury of testing the fiscal policy counterfactuals. We can only make our choices based on imperfect analysis and deal with the murky consequences as they emerge.
A very substantial medium to longer-term risk is the potential transmutability of the coronavirus scourge, from pandemic to endemic. Slower-than-expected vaccine distribution combines ominously with greater-than-expected virus mutations, suggesting that coronavirus may be here to stay. An endemic and ever-changing potentially lethal virus may be the new reality, causing governments, business and households to change policies, practices and behaviors. This new reality could lead to ongoing and perhaps accelerating creative destruction, amplifying the diverging fortunes of the K-shaped economy.
For a PDF version of this publication, click here: February 2021 U.S. Economic Outlook
