The Global Markets Weekly – 10/14/16

Posted October 17, 2016 by rvillareal

Potential Benefits of Running Hot?

With global growth in 2016 likely to post its lowest rate of expansion since the 2008-2009 recession, it is at first curious that one of the research questions posed by Fed Chair Yellen on Friday was whether there might be benefits from running the U.S. economy “hot” for a period of time. This comes just as DE sees the U.S. on track to post 1.6% y/y growth on average in 2016, which would match the lowest since 2011, after 2.4% and 2.6% in 2014 and 2015, respectively. In a 2-D world, the statement is odd because there are currently few if any economies in danger of truly redlining, including the U.S.. In a 3-D world, suggesting there might be benefits helps the central bank make a credible case for being a bit “irresponsible” in future states of the world.

That sort of commitment would mitigate a key complaint from some policy wonks, namely that one reason growth has been so anemic is that officials have been promising to normalize policy rates as soon as possible, working against the outcomes that would have made such normalization possible.

A channel through which Yellen posits faster growth might alleviate past ills is productivity, the slowdown being a key puzzle in data around the globe. U.S. productivity growth averaged a meager 0.5% y/y over the last five years, compared to a 20-year average around 2%, and nearer-3% in the late-1960s. Q2 2016 labor productivity actually turned negative on a y/y basis. In the EU, it has slipped to 0.8% on average in 2014-2015.  In Japan, labor productivity has improved at 0.4% on average since 2010, after a respectable 1.2% on average from 1990 to 2007.

The Fed Chair attributed the slowdown to weak investment, R&D, and a lack of new firm formations. She specifically asks whether “it might be possible to reverse these adverse supply-side effects by temporarily running a ‘high pressure economy,’ with robust aggregate demand and a tight labor market.” The causal chain would run through increased sales boosting capital spending, or rising wages bringing in potential workers, or by incenting firms to start new more innovative businesses. Given the generally low-productivity service sector has been accounting for fresh job gains, DE is skeptical a hot economy on its own will reverse a productivity slowdown that actually began in the mid-2000s.

But that matters less than the (at this point, potential) commitment to allowing a hotter economy, as it suggests that monetary policy may not be so quick to step on the brakes in the event fiscal policy turns expansionary in the U.S. and globally as 2017 rolls into view, a key DE theme. Loosening fiscal restraint is a key source for DE’s above-consensus 2017 and 2018 growth projections. Still, it remains to be seen if a “hot” economy will really be tolerated if, as DE expects, inflation picks up more rapidly in 2017. Key updates come this week in the U.S., U.K., and Eurozone, and quickening price inflation is likely across the board.

• S.: Hard data are largely limited to September consumer prices (Tu), housing starts (Wed) and industrial production (Mo), while FOMC Vice-Chair Fischer (Mo), NY Fed’s Dudley (Wed) and Governor Tarullo (Fr) will make appearances.
• Eurozone: As was the case with the last meeting, the ECB Council Decision (Th) has little high-profile relevance to markets, as no further action is expected from the central bank this time. The ECB may have to acknowledge the more upbeat signs from its own Bank Lending Survey update (Tu) which are likely to replicate, if not better, the results in July.
• UK: The UK media are starting to worry about the impact of the slumping pound on the price outlook. Indeed, the fall in sterling triggered a high-profile dispute between wholesalers and supermarkets over who should bear the increase in costs. In addition bond market yields have started to move higher. All of this makes the CPI and PPI inflation updates on Tuesday potentially more sensitive.
• China: Real GDP (Wed) growth is generally expected to hold steady at 6.7% y/y, while retail spending should continue to outpace industrial output.

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