The Real State of the American Economy

Updated March 15, 2017

I haven't posted on this subject for nearly a year but with the Federal Reserve's recent revelation that they might consider raising rates if labour market and inflation conditions looked "appropriate" as shown here...

"In discussing the outlook for monetary policy over the period ahead, many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the Committee's maximum-employment and inflation objectives increased."

... and the mainstream media's frothing at the mouth as shown here in an article on FT.com entitled "Fed Flags Interest Rate Rise "Fairly Soon"... 

"Many of the Federal Reserve’s policymakers said they should be ready to lift short-term interest rates again “fairly soon”, minutes from the last meeting (January 31 - February 1, 2017) revealed, setting the stage for intense debate at the next gathering as the US economy strengthens...Despite the background of political wrangling, the US economy has continued to see a robust expansion that many Fed policymakers think supports their median projection for three rate rises this year..." (my bold)

...it seemed to be a very good time to revisit a topic that provides us with insight about the strength of the economy in more-or-less real-time, insight that may show us the Fed's future policy direction.

What many business writers fail to do is examine the Federal Reserve's own tool that can be used to actually gauge the health of the economy.  The Center for Quantitative Economic Research at the Federal Reserve Bank of Atlanta has developed a tool that provides us with a predictor of the seasonally adjusted annual rate of real GDP growth called GDPNow.   The GDPNow model uses similar methods to those used by the Bureau of Economic Analysis (BEA) to estimate real GDP growth by using an aggregate of 13 economic subcomponents that comprise GDP.  As additional monthly economic source data becomes available, the GDPNow forecast for a given quarter is updated and its accuracy improves.  GDPNow forecasts begin the week after the BEA's advance estimate of GDP growth for the previous quarter is released and is updated six or seven times monthly with the following data points:

1.) Manufacturing ISM Report on Business

2.) U.S. International Trade in Goods and Services

3.) Wholesale Trade

4.) Monthly Retail Trade

5.) New Residential Construction

6.) Advance Report on Durable Goods Manufacturers

7.) Personal Income and Outlays

Other data releases including Existing-Home Sales and Industrial Production and Capacity Utilization are also included in the model.

Here is a table showing the data sources used to calculate GDPNow:

With this background, let's look at the latest GDPNow forecast for the first quarter of 2017 with the green line showing the evolution of the GDP growth forecast over the quarter as data has come in:

The current model predicts that GDP for Q1 2017 will grow by a tepid 0.9 percent, well down from the 3.4 percent predicted at the end of January 2017 and down 0.9 percentage points from March 1, 2017.  Here is a table showing how the data releases since the end of January have negatively affected the GDP estimate:

A growth level of 0.9 percent can hardly be termed a "robust expansion".  It is also well below historical economic growth rates as shown here:

Obviously, with its record-breaking policy of ultra-low interest rates, the Fed has painted itself into the "monetary policy corner" when it comes to dealing with the next economic slowdown/recession.  Obviously, the braintrust at the Fed is concerned about this very issue as you can see from this quote taken directly from the minute of the January 31 - February 1, 2017 FOMC meeting:

 "A few participants noted that continuing to remove policy accommodation in a timely manner, potentially at an upcoming meeting, would allow the Committee greater flexibility in responding to subsequent changes in economic conditions."

That sounds like a fancy way of saying "the Fed is screwed when the next recession arrives unless interest rates rise as we have promised".  If GDP growth is as low as the current GDPNow model predicts, the Fed may well be screwed and any lowering of their key interest rate will be temporary at best.