A Mixed Economic View

 | Jan 11, 2013 | 3:30 PM EST
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Having detailed the potential drag on consumer spending from the end of the payroll tax cut, one might wonder about the performance of the overall economy. The Chicago Fed released the results of its most recent Economic Outlook Symposium (PDF) on Thursday, summarizing the economists' views for 2013. The consensus is for the economy to continue growing moderately, roughly in line with its long-term potential. (Recall that potential GDP growth is determined by growth of the labor force plus productivity gains, which works out to about 2.5%.) The economy needs to grow faster than this to bring down unemployment significantly.

But with the economists' forecast of 2.3% growth in GDP in 2013, even though it's a bit better than 2012's projected 1.7% increase, job growth may only keep up with population growth. We might not be able to put the 12.2 million people who are officially unemployed back to work, plus the 1.1 million people who have given up their job search but still want a job. That means that the economists expect unemployment at the end of 2013 to be 7.6% -- not much different from the current 7.8%.

Even so, these economists project consumer spending to increase by 2.3%, an improvement from this year's projected 2% spending growth. I might be a bit more cautious due to the end of the payroll tax cut. First, a forecast for an increase in spending growth relies on some combination of either wage growth accelerating, more people working, the savings rate decreasing, or consumers receiving cash flow from other activities, such as investment sales or income.

What we see now is that the savings rate is 3.6%, a low level, given historical rates are more than double this amount, not to mention consumers' need to save for retirement. I might surmise that consumers might be wary about saving less, focusing more on wage growth to fuel an increase in their spending. Last year, aggregate weekly payrolls, a measure of what people earned on the job, increased by 4.2% in nominal (not inflation-adjusted) terms. (This is a function of more people working, working more hours and earning more per hour.) Based on the economists' forecasts for employment trends, we might reasonably expect this year to be a bit better than 2012 for wage growth.

Subtracting some amount for inflation, which forecasters believe will be 2.1% this year for the Consumer Price Index, we might arrive at about that forecast rate of increase for consumer spending. But what about the end of the payroll tax cut? Based on consumers' so-called "marginal propensity to consume" funds they will no longer have from the end of the payroll tax cut, that may reduce consumer spending by 1% from what it would be otherwise. That means consumer spending may come in weaker than the economists forecast, perhaps in the 1.5% range, give or take. Of course, consumers also derive income from other sources, or they might reduce their savings rate further as confidence from rising home prices causes them to spend more.

Meanwhile, the economists expect business fixed investment (property, plant and equipment) to increase by 3.5% this year, up from 2.5% in 2012. But we still have debates on government spending coming up, as recent legislation only dealt with the tax side of the budget equation. Businesses might wait for a full budget proposal and the other side of the trio of Congressional debates in the next couple of months on the debt ceiling, spending cuts and funding the federal government. These forecasts for government spending to contract by only 0.4% may understate the likely government spending cuts, leading to more optimism than is warranted on business investment.

Even with all that caution, there's reason for optimism. First, it's easy to believe consumers will buy more cars given the average age of cars is at a record high. We might see 15 million new cars sold this year, up from 14.3 million projected for 2012. Housing starts are projected to climb to 0.95 million this year from 770,000 in 2012, with real residential investment to increase by 9.4% in 2013.

All these data lead to forecasts for industrial production to increase by 2.7%, up from 2.3% last year. Economic growth is expected to improve over the course of the year, with GDP rising to 2.7% in the fourth from 2% in the first quarter.

Thus, while Washington's output may hinder the nation's economic output a bit, there is still ample reason to believe the economy may continue to grow at a moderate pace. Unfortunately, that won't be enough to bring down unemployment significantly.

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