While I’m gearing up for my economics class at Purdue, it’s a good time to take a look at the economy. Got to offer those eager young people the latest word.
Let’s start with gross domestic product, our main measure of goods and services production. GDP grew 1.2 percent above inflation from July 2015 to June 2016. That’s pretty slow.
Don’t blame consumers. Consumer spending increased 2.7 percent above inflation over the past year, and when people buy, businesses produce more products and hire more employees. There are good reasons to think that consumers will keep spending. Job prospects are better. Wages are edging upward. Home and stock prices are up. Let’s put consumers down for 3 percent spending growth next year.
Residential investment grew a healthy 6.2 percent above inflation over the past year. There’s only a five-month supply of houses for sale, and home prices tend to rise when supply is less than seven months. Rising prices encourage construction, and low mortgage rates should encourage demand. Let’s look for another 6 percent increase next year.
Investment in business buildings, equipment and technology fell 1.3 percent in 2015-16 despite corporate bond interest rates near record lows. One reason is the big drop in oil prices since mid-2014. Investment in new rigs doesn’t look profitable at those prices. Since capital goods orders have fallen for six months, it’s hard to see improvement. Let’s say we’ll see a 2 percent drop for next year.
The exchange rate of the dollar is up against most currencies since 2014. That makes our exports more expensive, and it shows. Exports are down 1.2 percent since mid-2015. Slow growth in the rest of the world limits exports too. Perhaps the effects of the rising exchange rate have played out, so put exports down for zero growth this coming year. At least that’s not another decline.
On the flip side, the strong dollar makes imports cheaper. Still, we didn’t import that much more last year, just 0.2 percent. In most years, import spending rises faster than increases in consumer spending, and with imports cheaper, spending likely will rise more — perhaps 5 percent over the next year.
Government purchases grew 0.9 percent over the past year. Federal gridlock and slow growth in local revenues will probably keep government purchases growth near 1 percent.
Add it all up, and GDP will grow 1.7 percent above inflation over the next year. That’s faster than it’s been, but slower than we’d like.
It’s enough for a small drop in the unemployment rate, from 4.9 percent now to maybe 4.6 percent by mid-2017. That’s getting awfully close to full employment, although other measures count more folks as unemployed. Still, once we approach full employment, it’s harder for businesses to find new employees if they want to expand. That means that output growth is limited by the growth in the labor force, and because baby boomers are retiring in large numbers, it’s growing slowly, only 0.9 percent over the past year.
Productivity is output per employee, which depends on the machinery and technology that workers use. Productivity has been falling over the past year, down 0.2 percent. Surely that won’t continue. But add slow productivity growth to slow labor force growth, and we’ve got to expect slow GDP growth.
Aside from oil price changes, annual consumer price index inflation has been within a point of 2 percent for the past 20 years. Oil price changes cause fluctuations, so the drop in oil prices cut inflation to 0.7 percent over the past year. Since oil prices are not expected to see big moves up or down, the inflation rate is likely to be around 2 percent through mid-2017.
The Federal Reserve seems to be looking for a reason to raise interest rates, and over the next year it may justify a couple of quarter-point hikes. That would push the three-month Treasury rate up from 0.3 percent now to 0.8 percent by this time next year. The 10-year Treasury rate was a really low 1.5 percent in July. That should rise too — to about 1.9 percent.
So expect more slow growth as the economy transitions from recovery to full employment, a small drop in the unemployment rate, “normal” inflation and an uptick in interest rates. Our mild expansion should continue for another year.
Larry DeBoer is professor of agricultural economics at Purdue University. Send comments to firstname.lastname@example.org.