4th Quarter GDP….Downward Revision….Keeps Us Guessing

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report
The BEA’s second estimate of 4th quarter GDP trimmed the growth rate to 2.2% from 2.6%. The downward revision will certainly give those more “patient” policy makers additional ammo to sit back and let the dust settle further before making any moves.

gdprealchgm-2015-02-27

Since the recovery began, real GDP has continued a long, slow climb out of the depths. As is evident in the graph below, the growth has been weaker than the typical recovery. Said differently, almost 30 quarters since the previous peak real GDP is less then 10% higher now; however, in the past real GDP was 20-30% higher after 30 quarters from the previous peak.

gdp-cyc-2015-02-27

Meanwhile, a version of the Taylor Rule with unemployment targeted at 6% and inflation at 2% calls out for an increase…and has been for more than 4 years.

taylor-rule-2015-02-27

However, average hourly earnings growth has been anemic, stuck around 2% since 2010, meaning any changes in real earnings came from changes in inflation. The latest drop in inflation has meant an increase in real hourly earnings of about 2%. As can be seen in the graph below real hourly earnings growth since 2010 spent lots of time in negative territory, rarely hit even 1% and has averaged about zero.

ahecpi-2015-02-28

Moreover, five year out inflation expectations are also low.

inflation5yr-2015-02-28

With no inflation pressures now or later, many on the FOMC likely feel little reason to begin liftoff. Indeed, from Chair Yellen’s remarks to Congress,

In sum, since the July 2014 Monetary Policy Report, there has been important progress toward the FOMC’s objective of maximum employment. However, despite this improvement, too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.

While many were thinking that liftoff might begin in the middle of this year, but these words from her testimony imply later rather than sooner,

The FOMC’s assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis.

But recent data have confirmed that falling oil and commodity prices may be masking movements in prices. Core inflation – excluding food and energy – jumped at the last reading and markets reacted.  The FOMC seems to be leery of acting too soon on liftoff but the bigger worry is that the costs of acting too late might be higher.

Finally, from the end of the testimony,

As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its objectives of maximum employment and price stability.

Good to know, thanks.

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