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Sunday, August 7, 2016

U.S. Economic Cycle Still Rolling Along At A Subdued Pace

Chart: U.S. Employment Ratio

The U.S. Employment Situation Report for July was decent, underlining that the expansion continues, despite the large number of potential headwinds. Although most attention is upon the Nonfarm Payrolls numbers, the employment-to-population ratio ticked up again in July. At 59.7%, it is only up marginally versus the end of last year. However, the ratio has tended to rise rapidly at the end of recent years, which is a possible sign that the seasonal pattern has shifted. If this is indeed the case, having the employment-to-population ratio go sideways during the mid-part of the year would be consistent with the "true" underlying trend remaining on the improving trajectory that we have seen since 2014 (which is well above the mediocre trend line that prevailed from 2010-2013, which is shown on the chart).

Chart: U.S. Participation Rate

The headline unemployment rate (U-3) was stable at 4.9% in July. The Participation Rate (shown above) has been choppy, but it is at the level first reached in late 2013. If the economy can continue to produce jobs at a faster pace than demographic growth, the participation rate should tend to recover, allowing the unemployment rate to remain near its current level. (I believe that the attempt to pin the fall in the participation rate purely on demographics was just an attempt to provide an excuse for poor performance.) Correspondingly, I doubt that the U.S. labour market is going to overheat any time soon.

Although I have sympathies with the view that the Fed needs to avoid triggering a recession, I do not see a huge roadblock to another 25 basis point rate hike in December. Even the most dovish Fed members can hardly be spooked by a rate hike cycle that consists of hiking rates 25 basis points per year. (This view is already incorporated into the forward curve, so I will not dwell upon it.)
Chart: Inventory Contributions To Real GDP

The only thing that can upset the rate hike cycle (if we still consider 25 basis points a year a cycle) is a recession. I normally focus on the labour market, as that tells us about inflationary risks during an expansion, while the precise factors that end the expansion are more eclectic. As I discussed in Section 5.3 of Interest Rate Cycles ("Post-Keynesian Economics and Recessions"), business cycles are typically caused by a reversal of investment.

A year ago, there were good reasons to be worried about private investment. The energy business was forced to retrench, and there was an inventory overhang. I will just comment here on the inventory overhang; for more background, I would recommend this article by Gerard MacDonell.

The top panel of the chart above shows the (annualised) contribution to real GDP growth by private inventories. As one can see, it swings around, adding to the noise of quarterly GDP (which is another reason not to obsess about the quarterly number). The bottom panel is the 4-quarter moving average, which one might hope approximates the contribution to annual growth. (Due to the wacky nature of real GDP calculations, this is certainly not the way to calculate that contribution exactly.)

The average fell to -0.6% in the second quarter of 2016, which is somewhat extreme for an expansion. If inventory growth just reverts to normal positive growth, that will represent a big positive swing in GDP growth arithmetic. In any event, in the absence of some form of sudden stop in the financial markets, inventories are unlikely to represent much of a drag going forward.

I cannot rule out some external factor leading to a sudden drop in confidence, but from a domestic perspective, the U.S. economy looks like it can keep muddling forward.

(c) Brian Romanchuk 2016


  1. The charts you show don't indicate to me anything except that inventory contribution to the economy bottoms out at the end of the last few recessions. And then that it jumps after. But there is a whole lot of jumping around regardless of the overall state of the economy.

    My point is that I have no idea what inventory accumulations or reductions mean anymore. Evidence of that is my comments on Bill Mitchell's August 1 blog post. If you find the time to explain about inventories that would be great. Be warned that I will always have many, many questions so don't feel obligated to answer any of them.

    1. Sure, inventories jump around, but they are usually correlated with the cycle. Historically (pre-1980s, say) inventory swings were larger, and were enough to cause recessions by themselves.

      The point of the chart (if there is one...) is that we have absorbed a big inventory hit, but no sign of a recession (or so I assume...). This means that if restocking begins, growth will get a boost, as inventories would no longer subtract from growth, and would start to add. This would probably be enough to keep the economy away from negative growth.

      There is not a whole lot of significance to these wiggles in growth during an expansion,but slow growth tends to scare people.

      I would recommend the article I linked for a more technical discussion; I will try to find the Mitchell piece.

    2. I took a look at your question. In an expansion, you would expect inventories to rise, as companies want to keep inventories stable relative to sales. If inventories get too big relative to sales, then management has no choice but to cut production. This is why inventories end up being pro-cyclical.

    3. Thank you Brian. I had read the article by Gerard MacDonell but my questions are too basic for that to help me much.

      It is very nice of you to look at my questions and I thank you for trying to help me understand this. I had not realized that companies would want to keep inventories stable relative to sales and that therefore inventories would rise as sales increased and that therefore overall gross inventory could be expected to increase with a growing economy.
      And I now see how rising gross inventories (rather than rising relative to sales) could be a positive sign for an economy. Thanks!

  2. Are those changes even statistically significant? I guess if you took the data just from 2014 to 2016 (looking at the graphs only) yes you could find some statistical significance, but otherwise...

    I mean, those changes could be just temporal and not due to structural changes on economic policy or structure. We will see over the next couple years.

    1. Or from an MMT point of view, looks like spending remains strong enough for 'muddling through' and as private sector keeps deleveraging and their balance sheets become stronger things will stabilise, but it may not be that straight:

      What would be good is to see an structure on private debt all around, if I recall correctly households are cleaning up their balance sheets, but on the other side sub-midcap corporations are soaking debt (there is a transfer from corporate balance sheets to households indirectly), and this could have made up what the govt has been lacking. Take for example the HUGE transfers to households that has come from now defaulting oil companies.

      If prices are not supportive and much of the recovery is based on current mark-to-market valuations on certain asset classes, this could break down easily again. Here are some mini-bubbles that have been popping around in USA: real estate in certain areas, tech-unicorn-IPO complex, oil (fracking), student debt. The third one is cracking down already, the second is showing weakness, and the first would follow the second in certain areas (ie. San Francisco), and is the one who will hit households the hardest.

      All those bubbles are smaller than the 2008 isolated, but we cannot diminish the impact on the recovery those have had.

    2. Or in an other way: while this trend may represent a temporal stabilisation due to all effects above (asset appreciation, stronger household balance sheets, and supportive enough govt spending), I doubt we will see significant growth until there is a realignment of wages with productivity gains over the last 30 years.

      The way to substitute income growth has been replacing it with wealth effects via asset appreciation. But as we know, that does not distribute evenly on the population, neither is sustainable (not everyone can be a real estate speculator).

    3. "I doubt that we will see significant growth..."
      What we have been seeing is what we should expect to see going forward, unless something changes. It's not particularly impressive, but the economy is growing. We would need to see some form of structural change for there to be much faster growth, but there is no guarantee that changes will result in faster, rather than slower, growth.


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