Private sector economists and those with the Bush administration have just released new economic forecasts with somewhat lower projections for economic growth in 2007. However, other than in the next couple of quarters, neither has lowered their forecasts for inflation at the consumer level.
Philly Fed Survey of Professional Forecasters
The Federal Reserve Bank of Philadelphia conducts quarterly surveys of private professional economic forecasters. The survey size is typically around 50 forecasters. The charts below compare forecasts compiled just prior to a news release date of November 13, 2006 versus the prior compilation released August 14, 2006.
Real GDP growth has been revised down through next year but the downward revisions are primarily in the current quarter and in the first quarter of 2007. Private forecasters still see a gradual rebound in growth from the anemic third quarter growth rate of 1.6 percent. By mid-2007 growth is almost back to a 3 percent annual pace.
Real GDP is now forecast to come in at 2.6 percent in 2007 on an annual average basis, compared to the August compilation which had 2007 growth at 2.8 percent. It is important to note that the apparently moderate growth of 2.6 percent is a statistical artifact of using annual averages. Weak growth at the end of 2006 is what pulls down the average level for GDP in 2007. On an annualized quarterly basis, real GDP is projected at a notably stronger 2.9 percent from the second quarter of next year as the drag from housing is less negative.
The quarterly figures for the fourth quarter of 2007 for the August compilation are not available.
The relatively strong GDP growth means that the economy spends very little time below potential GDP. The Office of Management and Budget has estimated potential GDP growth at 3 percent but Federal Reserve officials have indicated that they have revised potential (non-inflationary) growth downward due to the leading edge of the baby boom generation entering retirement and leaving the labor force. This keeps upward pressure on inflation and is seen in the CPI inflation forecast for 2007 which is unchanged at 2.6 percent.
The lack of progress in the inflation forecast (no deceleration) should be disconcerting. While the Fed is forecasting a decline in core inflation, by 2007 energy effects should no longer be pulling overall inflation up at a pace faster than core inflation. Many of the private forecasts probably do not include the October drop in the CPI but much of that was probably anticipated due to the known drop in crude oil prices. On a quarterly basis, overall CPI inflation is forecast at a 2.5 percent annualized pace for the third and fourth quarters of next year. This is still well above the Fed's comfort zone of 1 to 2 percent consumer price inflation.
Private forecasters have notably lowered their projections for interest rates levels. Private forecasts for short-term interest rates have rates down about 20 basis points with the 3-month T-bill coming in at 4.8 percent by the third quarter of 2007. This implies a forecast for the Fed to cut the target fed funds rate to 4-3/4 percent by the third quarter of next year since these two short-term rates run together closely.
Long-term interest rates are now about 30 basis points lower in 2007 than previously forecast.
The forecast for such lower long-term interest rates is somewhat curious. Certainly, there is an implied forecast for a cut in short-term interest rates by the Fed. But the Fed can only directly control short-term rates. Long-term rates are affected by demand for borrowing and by inflation expectations. Overall economic demand is strong, given the forecasts for essentially 3 percent real growth by spring 2007. And inflation is expected to come down almost imperceptibly, indicating that any inflation premium in long-term rates should be little changed.
The only possible explanation for the lower long-term rates is a forecast for a flat housing sector. Housing starts are projected to stay near 1.6 million units annualized over the length of the forecast. A flat housing sector appears to be a key reason for long-term rates to ease. Otherwise, there appear to be inconsistencies between overall economic growth and somewhat high inflation to the drop in long-term rates.
By components in GDP, residential investment is where the largest revisions are. Residential investment growth has been pushed down in both 2006 and in 2007. In contrast, forecasts are holding steady for moderately positive growth in nonresidential fixed investment - inclusive of equipment, software, and structures.
Private forecasters see the consumer sector continuing at a healthy pace as previously forecast. Real consumer spending is seen coming in at 3.1 percent in 2006 and at 2.8 percent in 2007. Net exports are projected to be a moderate negative in 2006 and a mild positive (narrowing gap) in 2007.
Private forecasters see little change in the unemployment rate next year, anticipating a rise to 4.8 percent on an annual average basis from 4.7 percent in 2006.
Corporate profits on an after-tax basis are seen as still positive in 2007 but at a much slower growth rate, coming in at 4.8 percent in 2007 after 20.7 percent in 2006.
Recent Economic Projections by the Council of Economic Advisers
The Bush administration publishes regular economic projections through the Council of Economic Advisers (CEA). The CEA publishes forecasts twice a year - once in June and again in November. The fall forecast generally is used for the President's Fiscal Year budget.
The administration's latest forecast is very similar to the composite private sector forecast. However, the administration focuses on yearly changes on a Q4-to-Q4 basis instead of using annual averages.
The administration is a little more optimistic about real GDP growth than private forecasters - but not by much. GDP is seen posting 2.9 percent growth in 2007 and 3.1 percent in 2008. Overall CPI inflation is forecast at 2.6 percent for both 2007 and 2008.
On interest rates, the CEA is a little more optimistic than the private sector on short-term rates but less so for long-term rates. On an annual average basis, 3-month T-bills are projected to be 4.7 percent in 2007 and 4.6 percent in 2008. The 10-year bond is forecast to average 5.0 percent in 2007 and 5.1 percent in 2008. The CEA sees a tighter labor market than private forecasters. The unemployment rate is forecast to come in at 4.6 percent in 2007 - the same as in 2006 on average - and edge up to 4.8 percent in 2008.
The bottom line
On average, private forecasters and the Administration expect the economy to rebound moderately in 2007. Unemployment is projected to rise but only marginally. Interest rates are expected to come down even though no progress is forecast on the CPI inflation front. This latter projection should be a cause for concern. The Fed is not likely to be happy about an inflation rate that stays above 2-1/2 percent for that long and this fact could rewrite the forecasts over the next quarter or so as the Fed could choose to leave fed funds unchanged longer than currently forecast.
R. Mark Rogers, Senior Economist, Econoday
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