Jan 30, 2018

2018 State of the Economy Q&A

Scott Sumner Ralph G. Hawtrey Chair Emeritus of Monetary Policy

Today is the date of President Trump’s 2018 State of the Union address and the start of the Federal Open Market Committee’s (FOMC) first meeting of the year.

Why it matters: The State of the Union address will likely set the stage for many policy debates leading up to the 2018 midterm elections, and the FOMC’s monetary policy decisions could have significant effects on future economic growth. Both events make this an important day to consider the state of the American economy in the year ahead.                                                                                                                      

Q&A with Economist Scott Sumner

Overall, how would you describe the state of the US economy in 2018?

I expect more of the same in 2018, which might be viewed as an optimistic forecast, as 2017 was a pretty good year.  I expect the real economy to grow about 2% this year (fourth quarter of 2017 to fourth quarter of 2018), and unemployment to decline to slightly below 4%.  The global economy also looks pretty strong right now, and that will help to boost the US economy.  Tax reform may add a couple tenths of a percent to growth.

What are the “best” and “worse” case scenarios for the economy this year that you could actually see happening?

The best case would be if tax and regulation reforms led to an even more pronounced increase in economic growth.  I expect the effects to be quite modest, but this is an area that economists are not good at forecasting. 

The worst case would be an international trade war, triggered by protectionism in the United States and a breakdown in Brexit negotiations in the European Union.  There is a rising tide of nationalism in the world today, and that’s historically been bad news for the global economy.

As the year goes on, what are a few economic indicators that you’ll be keeping an especially close eye on?

At the macro level, I’ll be watching nominal GDP (NGDP) growth, which is the single best indicator of the effect of monetary policy.  I’d expect just over 4% NGDP growth in 2018. 

At the regional level it will be very interesting to watch the impact of tax reform.  The $10,000 cap on state and local tax deductions may push high tax states like California and New York to reduce their rates.  If they do not do so, will firms move to places such as Florida, Texas and Washington, none of which have a state income tax?   

Which policy areas being talked about by Congress or President Trump do you think have the most potential to improve economic growth now and in the foreseeable future?

There’s still much work to be done on tax reform, but that seems unlikely after the recent effort.  Instead I’d point to healthcare and immigration as two areas where policy reforms could substantially improve the economy.  With healthcare, the focus should be on using deregulation to bring health costs sharply lower. 

On the immigration front, allowing higher levels of immigration, especially among skilled workers, would provide a big boost to the economy.  Other areas that are holding back growth include restrictive zoning laws, as well as occupational licensing laws.  But these are mostly state and local policy areas.

If you were in the FOMC meeting today, what might you say to the Committee?

The time to fix the roof is when the sun is shining. Inflation is slightly below the 2% target, and the unemployment rate (4.1%) is slightly below the Fed’s estimate of the natural rate of unemployment (4.6%), so the current stance of policy is not the problem. 

Now is the time when the Fed needs to prepare for the next recession. 

They can do so by insuring that they have adequate tools, and also set up a policy regime that is more stable in the sort of crisis we had in 2008.  Beefing up the tools would including announcing that the Fed is willing to cut interest rates below zero, and engage in almost unlimited open market purchases if necessary to hit their target.  Fixing the regime would involve switching to price level targeting or to nominal GDP level targeting.

 

 

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