How The Federal Reserve Sees The Economy

Officials at the Federal Reserve moved ahead and raised the policy target range for the Federal Funds rate to 2.25 percent to 2.50 percent.

I think that it important to see that the vote for this change was unanimous, showing the desire of the leaders of the Fed to show President Trump, and the world, that there was no division on this move.

The one concession that was made, signaling only two more possible increases in 2019, down from the previous signal of three possible increases in 2019, was, in my mind, a throw-away. After all, the Federal Reserve is “data driven”.

The most important thing, for me, that came out of the Fed’s FOMC meeting, were the forecasts Fed officials were founding their decision on.

The most important change, I believe, was the downward revision of inflation.

For 2018, Fed officials are not expecting the rate of inflation to come in at 1;9 percent, down from 2.1 percent in the last projection. Fro 2019, the inflation rate is expected to also come in at 1.9 percent, down from the previous 2.0 percent.

Going further out, the projections for inflation are as they were before, 2.1 percent for both 2020 and 2021, with the longer-run forecast coming in at 2.0 percent.

I have noted in recent posts, here and here, how investors in the bond markets have recently revised their expectations of future inflation. The 35 percent drop in oil prices over the past three months has contributed to this drop in expectations.

Federal Reserve officials have apparently moved their forecasts down as well, responding to the current movements in oil prices. Analysts say that this decline reflects both a condition of over-supply of oil, possibly coming from the fact that the United States is now the number one source of energy products in the world, and from a slowing in demand for oil as economies throughout the world experience slower growth.

In addition to these revisions to the price outlook, Fed officials also dropped their projections for the growth of real GDP for 2018 and 2019. For 2018, the growth rate was revised from the previous expectation of 3.1 percent, to 3.0 percent.

For 2019, the projection was dropped from 2.5 percent to 2.3 percent. For 2020 and 2021, Fed officials held onto their previous forecasts of 2.0 percent and 1.8 percent, respectively.

Note that these numbers are fourth quarter to fourth quarter rates of growth.

Right now, the year-over-year growth rate of the U.S. economy is 3.0 percent for the third quarter. This is spot on with the Fed’s new forecast of 3.0 percent for the fourth quarter of 2018, year-over-year projection.

To put this performance into perspective, the fourth quarter, year-over-year, growth rate has been 2.0 percent in 2015; 1.9 percent for 12016; and 2.5 percent for 2017.

In other words, Federal Reserve officials have seen some pickup in economic growth over the past year or so, but, the longer-term effect of this pickup is relatively minor. And, they feel that inflationary pressures are really nowhere in sight.

The reasoning behind these forecasts, I believe, is that analysts in the Federal Reserve see the economy progressing over the next four or five years, much in the same way it moved forward since the Great Recession.

Note, that the current economic recovery will pass the 10-year mark next summer, making it the longest recovery on record since the Second World War. And, although the growth rate has seemed rather anemic, coming in at a compound rate of growth of around 2.2 percent, the unemployment rate is now at a rate not seen for a very, very long time.

The only cloud on this fact, is that the labor force participation rate is at a low not experienced since the late 1970s.

This low labor force participation rate, I think, points to the fact that the economy is going through a tremendous transition period now as it moves further into the information age and away from the industrial age. We see this transition in the way the "new" Modern Corporation is becoming the predominant organizational model in the economy.

We see this transition is the hiring going on in the labor market. Things are different now than they were ten, twenty, or thirty years ago.

As, one of the places this transition seems to be impacting the economic statistics is that the growth of labor productivity has become minimal. This does not mean that the new technology is not more productive in many ways. It does seem to indicate that our measurement of labor productivity needs to be reconsidered.

Since the “new” Modern Corporation is constructed around intangibles, like intellectual property, and thrives off of enormous scale created within the platforms and networks created from this intellectual property, the old concept of productivity may not capture all that is going on.

But, then, these changes may not fully be captured by the idea of Gross Domestic Product, a construction relating to the Industrial Age, where “things” were the major output.

Still, we base a lot of our decisions upon the measure Gross Domestic Product, which is “thing” based, and the productivity that produces these “things.” Thus, the growth of labor productivity is crucial to understanding the growth rate of real GDP.

Here we see that during the current period of economic expansion, the growth of labor force productivity has been extremely low and, consequently, the growth rate of real GDP has also been extremely low.

It seems to be that this supply side dynamic is dominating the rate of economic growth that has been achieved over the past ten years. And, it is this fact that is built into the Fed’s projections of economic growth over the next four to five years.

These numbers also seem to indicate that a tax cut policy, like that produced by the Trump administration a year ago, can have a minor short-term impact on the economy, but unless the policy makes some major changes to the longer-run productivity of the economy, economic growth will not be influenced much by the effort. Tax breaks going into stock buybacks do not improved the productivity of the economy over the longer-run.

This seems to be the thing the Federal Reserve projections are reflecting.

Economic growth remains positive, but still modest, and inflation continues to run under the Fed’s policy target. Hence, the policy target range for the Federal Funds rate can be raised.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.