The Fed sees a darkening future – and the key fact about our economy

Summary: Today’s economic forecast by the Fed gives us another dose of bad news, wrongly overshadowed by their decision not to raise interest rates (resulting from it). Ignore economists’ guessing about the next tick up or down in the economy. The key insight is that America can’t grow fast but cannot afford to slow.  {2nd of 2 posts today.}

Fast Snail



  1. A darkening Fed forecast
  2. America in the “coffin corner”
  3. For More Information

(1)  A darkening Fed forecast

The Fed’s forecasts get too little attention, although they play a large role in the setting of Fed monetary policy. Since the crash the Fed has started its out-year forecasts high, and then dropped them at an accelerating rate as they approach the present. The high end of 2015 has fallen 40% vs. a fall of only 4% for 2017. Hope dies slowly.

  • 2015 from 3.0 – 3.8% in Sept 2012 to 2.0% – 2.3% now.
  • 2016 from 2.5 – 3.3% in Sept 2013 to 2.2% – 2.6% now.
  • 2017 from 2.3 – 2.5% in Sept 2014 to 2.0% – 2.4% now.
  • 2018 started at 1.8% – 2.2% (median of 2.0%).

As this graph shows, since the crash GDP has swung between 1% and 3%. When GDP falls below 2% the odds of a recession rise rapidly. This recovery already has had two close calls. The Fed responded to the slowdown that began in Q4 2010 with QE2 (Nov 2010), and to the slowing  that began in Q2 2012 with QE3 (Sept 2012).

FRED: real GDP

America’s economy in the “coffin corner”

Readers of the FM website have seen my long-standing prediction of this situation. Most clearly started in The dilemma of the US economy: can’t take off & too close to the brink. Lombard Street Research described it more analytically in Has America’s economy entered the “coffin corner”? — Excerpt…

The question is whether advanced economies, in an effort of trying to limit the damage caused by the Global Financial Crisis, have put themselves into a debt coffin corner. With debt-to-GDP (altitude) as high as it is, they can’t allow growth (airspeed) to slow too much, or debt risks becoming unsustainable. At the same time, high debt levels are likely to be a material drag, making growth hit an insurmountable economic “sound barrier” much earlier. This is because without the boost provided by credit growth, it is difficult to achieve the kind of GDP growth that was possible when debt-to-GDP was lower.

But there’s more. High levels of debt-to-GDP ratios make it difficult for governments and central banks to steer the economy – just as excessively high altitude makes it difficult for a pilot to keep control of the aircraft. Central banks have successfully employed Zero interest rates policy (ZIRP) to keep debt sustainable but, as the economy continues to recover, they may now find themselves cornered: keeping rates as low as they are may lead to overheating (or even bubbles) in certain sectors of the economy; but raising them may stall others by making the existing debt impossible to service.

I strongly recommend reading those two posts. You’ll probably gain more from them than reading today’s flood of information guessing about the next tick up or down in the markets and the economy. We are not in a normal business cycle. Until we see that, we understand nothing about the situation of the economy.

Only bold action can break us out of this dilemma, measures now politically unacceptable. But they’ll quickly become mainstream when we fall into the next recession (given our weak condition, any shock could push us over). I suspect it will be quite exciting.

Crystal Ball

For More Information

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12 thoughts on “The Fed sees a darkening future – and the key fact about our economy”

  1. Does the growth slowdown result from:
    a. excessive debt?
    b. reduced innovation and efficiency improvements?
    c. increased regulatory interference?
    d. something else?

    1. John,

      That’s an incisive question! Usually large scale system problems result from multiple failures. Many things had to go wrong to sink the Titanic and kill so many of its passengers and crew. So it is with the US.

      Historians will sort thru the data with their superior perspective. My immediate guesses about the key factors (in no order):

      • Too much private sector debt.
      • Demographic headwinds.
      • Slow growth abroad.
      • Our strong dollar fetish, keeping the US dollar too strong.
      • Unwillingness of the government to borrow to fund valuable (even necessary) infrastructure projects, as they prioritize low taxes for the rich.
      • Tech innovation continuing its multi-generational slowing.
      • Rent-seeking become too large a part of the economy (a sign of senescence).
      • Update: A large chunk of our income has shifted to the 1%, who have a low propensity to spend. This slows growth.

      The last might be one of the most important. Some of our largest sectors have become almost parasitic, dominated by their ability to extract “rents” from the economy (income beyond their value-added): education, health care, and finance.

      As for the others you mention — I see few signs that increased regulation has had much effect. Improved efficiency would tend to increase growth (unless we get too much of this good thing, when it might becomes destabilizing).

    2. I’ll throw my two cents in on this one. Speaking from a more theoretical point of view, the primary issue is lack of demand. Why, you may ask, do we have a lack of demand? Then I fall back to the same things you guys have already touched on.

      Excessive debt isn’t really a big problem right now because people remember all too well the excesses that led up to 2008 and most people are trying to avoid a repeat, this leads to them being unwilling to take on more debt rather than being unable to take on more debt. Government spending is a key issue right now. The Chinese government is trying to stimulate an economy that badly needs a rest. The Europeans have taken the opposite approach and are going with austerity, which is mostly hindering rather than helping but is more politically palatable to the powers that be. The US is in between but benefited quite a lot from the surge in spending at the beginning of the Obama administration. It is too bad that tailed off all too soon.

      Overall regulatory interference seems to be the least of the problems in the US. Some levels of government have added regulations and some have reduced them. China doesn’t seem to have quite enough regulation (ie. exploding warehouses) and Europe has developed such a mess of regulations that I’m glad I’m not trying to do business there.

      Demographic headwinds are definitely a contributor across the entire developed world and China. Again, the US is generally handling the situation better than Europe, China, or Japan.

      The lack of willingness by corporations to invest large sums in research and new products is a bigger factor and is an odd one. The companies that are investing in research in a disciplined way (Apple and Google for example) are reaping considerable rewards. But CEOs seem to believe that they can more predictably benefit from financial engineering than from R&D and I am not in a position to say whether or not they are right.

      I believe (based on insufficient evidence) that the primary problem is concentration of wealth (particularly in China) and the hollowing out of the middle class (particularly in the US and Britain). This has led to more and more of the middle class renting their homes instead of buying them, reduced the median (not the average) disposable income, and reduced demand.

      1. Pluto,

        All good points. However, I believe you conflate things happening now (with large effects in the future) with those that happened in the past (producing the slow growth since 2000). Most factors have large effects on the massive US and world economies only slowly (i.e., with long lags).

        Almost everybody agrees that the private sector debt accumulated since ~1980 has become a drag on spending (aka demand). Ditto demographics.

        “The lack of willingness by corporations to invest large sums in research and new products is a bigger factor and is an odd one.”

        First, I don’t believe the data shows this having an effect yet. But if continued it will in the future. Second, it’s not odd at all. CEOs respond to incentives. Returns on their stock options from investments in R&D and capex are slow and uncertain. Returns from mergers, acquisitions, and stock buy-backs are large, certain, and fast. Since their Boards of Directors are lapdogs and fanboys, what’s to stop them? Nothing.

        Concentration of income has an effect. Other than economists shoe-shining the 1%, I can’t imagine why this is not obvious. A large chunk of our income has shifted to the 1%. They of course have a low propensity to spend, and so much of that gets saved — slowing growth.

        Slow tech change has had an effect, although difficult to measure or even describe. However the 3rd industrial revolution has begun, and its massive effects lie in the future.

  2. Let us suppose the bold action either is not forthcoming or it manifests itself in something lilke the Iraq War, bold but catastrophic.

    What could you or I do, on our own, to offest these problems at least so far as our own affairs are concerned? Or are we doomed to sink along wth the rest of the Titanic?

    1. Duncan,

      “are we doomed to sink”

      Recession are part of the business cycle, an inherent part of free market systems. Good economic management can reduced their frequency, duration, and magnitude — but not entirely prevent them.

      The keys to easily riding out cycles are obvious: low debt levels (without balloon payments) and high levels of cash reserves (save and liquid, proportionate to the security of your income). Unfortunately American have done the opposite: jobs are less secure than during the post-WWII era, savings are lower, debt levels are much higher. This means the next downturn could be unpleasant.

  3. Several comments

    1) The “dead hand of rent”. Including the educational, health, finance, and imperial maintance (defense, spy agencies. Homeland Security, most of DOE, State Dept, propaganda and assorted NGOs) a rough estimate puts at least 5+18+15+7=45÷ of the GDP in the “rent” sector. Adam Smith would roll over.

    2) Propensity to Spend. This fact (too much $ in the 1%) contributing to lack of demand was well known last time in the 1930s. Economics has become a pseudo science by not incorporating such obvious phenomina. (Money has started to corrupt other fields. What can we now trust in medical journals for example?)

    1. Social Bill,

      (1) Defense spending is not a “rent”, economists define it. Also, defense spending has not grown over the levels in Cold War – Vietnam War era.

      (2) “Economics has become a pseudo science by not incorporating such obvious phenomina.”

      Economists understand quite well the importance of rising propensity to save. The question, as usual, concerns magnitudes and rates of change — about rising income inequality.

      (3) “money has started to corrupt other fields”

      I agree. That’s one of the great unknown trends of our time. Professionalism has collapsed during the past generation for a wide range of fields: CEO, doctors, scientists, etc.

  4. FM’s summary of reasons for secular stagnation seem to nail it exactly.

    How to eliminate those?

    We might begin by prosecuting and throwing into prison the Wall Street criminals who crashed the economy, imposing truly progressive taxation (top marginal rate of 90%, anyone?), enforcing anti-trust regulations to break up monopolies and monopsonies and duopolies like Comcast/Time-Warner, Wal*Mart, Microsoft, and Apple computer. We also need to drastically raise the Earned Income Tax Credit, mandate free child care for single mothers who want to work, drastically cut back on our endless unwinnable foreign wars and their associated wasted “national security” spending and shovel that money into rebuilding our decayed infrastructure.

    Also, we need to make joining a union easy and remunerative, instead of letting corporations punish workers for pro-union organizing. Along the way we need a lot more stringent regulations on the financial sector, and we need to find a way to shrink the finance sector as a proportion of the U.S. economy — perhaps via a financial transaction tax?

    1. Thomas, while you’re not wrong about a lot of what you say, all of your solutions require government intervention. Considering the fact that the 0.01% are increasingly in control of government, how do you propose to enact the desired changes?

      The most likely government intervention is for the NSA to send the cops to your house to politely ask (this time) for you to stop agitating.

  5. That’s beyond ridiculous, Duncan. If America has reached the point where suggesting anti-trust legislation induces the NSA to “send cops toyour house to politely ask (this time) for you to stop agitating,” it’s all over. Walk away. Society is dead.
    Incidentally, the NSA is an intelligence analysis outfit. It has no “cops.” Just guys sitting around running computer programs in cubicles.

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