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Economic Growth in the US ... The Short and Long Term

money.jpgThat the US has been and is slowing down considerably in the third and fourth quarter of 2006 should not surprise many readers I suppose. However, some of those illusive questions remain and most importantly is the question of whether we will have a hard landing (for example 0% GDP growth in the 4th quarter, i.e. a recession) or a soft landing (e.g. 2-2.5% GDP growth). I won't stick my neck out on either of the two scenarios but obviously US economists are watching the data closely. This also includes the US econ-bloggers and some of the best have recently been following the discussion closely. Let us begin with Dave Altig who furnishes us with the November reports on industrial output and retail sales which seem to hail a somewhat brighter future than we might have expected.

Your first present this week was the November retail sales report, suggesting that rumors of the consumer's demise may be greatly exaggerated.  More modest glad tidings came today in the form of a November industrial production report that at least wasn't as bad as expected.

However, the real issue here is inflation and whether a rising inflation was going to linger despite lower growth rates. As such, it has long been one of the ground pillars in the most ardent pessimists' views that the inflation would stay afloat despite a considerable GDP slowdown thus prompting a situation resembling the much dreaded stagflation in the 1970s. So should we adjust to the rear-mirror view here? Well not quite yet as Dave quotes Mark Vitner (from Reuters)...

All we wanted from this holiday season was a little more growth and a little less inflation, and Santa looks like he has delivered. This is just a great report," Mark Vitner, an economist at Wachovia Securities in Charlotte, North Carolina

But as we dig deeper through Dave's analysis and sources we clearly need to hedge our bets but whether we are going to fall into stagflation seems a bit more unlikely I would say. Another place to look for excellent commentary on the recent data releases in the US and general economic outlook is over at Mark Thoma's place where Mark reports on the recent Fed watch by Tim Duly asking, where is that recession? Mark's piece has so many interesting points and references and I can only recommend you to read it. 

One thing which is of particular interest though to the immediate state of the US economy going into 2007 is this where Mark shows why might want to be optimistic on domestic consumption ...

(...) let’s take the inflation adjusted estimate of real retail sales from the St. Louis Fed – last time I noted that this was a good estimate of real personal consumption expenditures. In real, annualized terms, retail sales are up 13.2% in November. And suppose real retail sales are flat in December. Then 4Q07 real sales will be up 4% over the previous quarter.

Needless to say, 4% consumption growth would pretty much put to rest any idea of a recession in 4Q, especially if trade makes a positive contribution as October’s contraction in the trade gap implies. And if 4Q comes in reasonable (consider the implication of strong consumption and a mix of other components that effectively cancel each other out), the Fed is not likely to change policy until they get 1Q07 numbers in late April.

However, as I am interested in demographics my radar also did pick up on Mark's elaboration on one of Bernanke's recent speeches in which the chairman highlights the effects of the retiring baby boomers on US trend growth, or more specifically; the transition mechanism between the labour force participation rate and trend growth.

This one in particular from Bernanke is interesting ...

Even if productivity growth is sustained at a reasonably good rate, the slower expansion of the labor force will imply some moderation in the rate of growth of potential output over the next few years. In the very near term, that slower growth in the labor force needs to be taken into consideration when assessing the sustainability of given rates of expansion in economic activity.

And also this one from the Fed in Philadelphia by Charles I. Plosser is noteworthy ...

Of course you might ask, what is trend growth?  Well, over the years I have told this group that the easiest way to think about trend growth is to look at the growth in the labor force and the growth in productivity—add them together and you can come up with a rough estimate of the sustainable trend growth in real GDP.


In fact, over the next decade or so we might expect to see trend growth decline further as the growth rate of the labor force slows. Although we frequently note the role of productivity in determining trend growth, the contribution of labor force growth is often overlooked. As the baby-boomers retire, demographic analysis suggests that the growth in the overall labor force will slow.  Moreover, we are no longer getting the boost in the labor force from a growing number of women entering the work force, and we also have somewhat lower fertility rates.

There is clearly a stark difference between the short term and long term in this post and I do believe that it is likely that the US is drifting below the (current) trend growth mark going out of the 4th quarter, the long term trend in the LPTR notwithstanding. Nevertheless, there are interesting things going on here and what we see above is a very sound attempt to piece together some of the causal links and transition dynamics I think.  


Adjusting the Views on Japan?

Japan.jpgI have finally emerged from my exam hibernation to re-commence regular blogging here at Alpha.Sources. I am furthermore going home to Denmark on Friday after having spent 5 months in Montreal at HEC Montreal  ... 5 great months I have to say! However, let us get down to business ...

In my comments on Japan here at AS I have consistently advocated a rather pessimist discourse on the economy primarily driven by my belief that the economy is in a structural bind with a continuing downward trend in consumer spending regardless of the how well the corporate sector (i.e. the export sector) fairs. In short, I do not see Japan returning to a balanced growth path anytime soon (neo-classical growth proponents, take note!) and my analysis fundamentally hinges on the strong life-cycle component of the domestic consumption trend or put in another words; demography matters here! 

Apart from my personal stubborn and persistently pessimistic position on Japan I also in all fairness have to point the data which has done nothing but support mine (and other's) narrative on Japan. Specifically, I am talking in a large (about 1 year) perspective. Consequently, it is sometimes nice to step back and look what has actually happened since Japan chose to end ZIRP back in the late spring this year. Back then, the move by the BOJ was widely seen as one of many steps in a long consistent process to mop up excess liquidity and normalize Japan interest rates, Japan was back amongst the leaders! Clearly, this has not been the case and one of the most striking features about Japan in the moment is how the BOJ just cant seem to find the economic justification to begin to turn off the money tap. Meanwhile, some of the most brilliant economic commentators still argue that it is only a matter of time before we see the much allured spill-over effect from the sparkly corporate sector to domestic consumption, that is the transition to a balanced growth path. We only need to wait. All this is of course being printed along side an inflation rate which is still flirting dangerously with the 0% mark and thus negative range and this has many thinking overtime because why is inflation so low in the light of a tightening labour market for example? Some indeed has come along way in seeing this correctly, and now also the big guns (i.e Morgan Stanley again) is also at least opening a backdoor as a hedge against the traditional positive stance ...

What we outline here is a risk scenario, not our main one. Nevertheless, we do not think it is a low-probability scenario, considering that the latest reading on price growth is very low, at just 0.1% YoY. In light of oil price trends, the Japan-style core CPI could contract again YoY in 2007 H1, contrary to our constructive economic outlook.


The recent, substantial, retroactive GDP revisions [see also here] confirm the weakness in the core of core CPI. For the F2006 national accounts, real GDP was revised downward by 0.9 ppt to 2.4%, which should have more than a negligible impact on estimates of the output gap since the economy’s potential growth rate is just shy of 2% at best.   Based on the revised GDP data, the pace of the contraction in the output gap in F2006 declines by almost 1 ppt. If the improvement in the output gap is only modest, the spillover effect on prices would naturally be that much weaker.

Also please take note of this ... the return to ZIRP is not a fairytale but a distinct possibility.

If the Japan-style core turns negative several months after the next rate hike, it would be easy to imagine the BoJ being in a politically difficult situation in terms of putting a crimp in the Cabinet/ruling coalition’s pro-growth policies.   Governor Fukui would not likely have to resign, but the choice of his successor after his term ends in March 2008 could be affected to some extent. To be more specific, Deputy Governor Toshiro Muto, who is currently widely expected to be the next governor, may be less likely to be promoted and the government and the ruling coalition may instead look for a candidate outside the BoJ


If someone with a strong monetarist bent is named to be the next governor, Japan could be stuck in an ultra-low rate environment for a long time, with price growth hovering very low. If policy is focused on an increase in money supply, the BoJ may increase the supply of reserve deposits and put the policy rate back to near 0%.

I think the key words for reading the Japanese economy at the moment is a bit of open mindedness in terms of what we could call the traditional/text book macroeconomic convictions. It should be quite clear for regular readers that I believe demography is a key determinant here. However, this does not mean that demography is the holy grail which can be applied universally to all macroeconomic issues. But in the case of Japan, the demographic economic analysis which is clearly an analytical field in development represents a very strong theoretical anchor for understanding what is going on; at least I believe this should be clear by now.