Faster NGDP Growth, what does it mean?

NGDP growth has accelerated in recent quarters. When we average NGDP and NGDI (Nominal Gross Domestic Income), we get, at a yearly pace, 5% for Q3, 3.7% for Q2 and 4% for Q1. Not jaw-dropping numbers, but the best run we’ve seen since 2014.

It’s also worth looking at the figures in quarterly form, rather than just year-over-year, as inconvenient as it may be. It turns outs that the best way to predict NGDP growth, is to simply look at recent quarterly growth. In developing our forecast models, we found that sub-models that rely on only a single quarter of lagged NGDP growth can outperform models with more lags. At most, our sub-models use five lags, meaning you don’t have to go too far back to fully capture the statistical signal as to the economy’s ‘momentum’.

This idea of NGDP momentum can be shown visually by looking at moving averages of the quarterly growth rate, shown in the plot above. Moving averages from three to five quarters have moved from just above 2% in 2015 to about 4% today. If the current quarter comes in at a yearly pace of 4.5%, as seems reasonable, then cumulative NGDP growth will be around the highest since 2014.

This time, things are different

Ordinarily, the Fed would use a rising NGDP growth trend as an excuse to unwind some of its balance sheet or to raise rates, as it did in 2015. There is good reason to think that this time they will not do this, however.

The biggest nod in favor of a more restrained response by the Fed in 2018 is the markets themselves. The rally in stocks is of course well covered, but other assets points to easier money too.  Copper prices are back to 2014 levels, TIPS spreads have railed in late 2017, though are still below the “magic” 2% number, and the dollar has been slaughtered in 2017, with the broad, trade-weighted dollar index at a Trumpian low.

Some may object and say “yes, but markets were wrong about growth in 2014, they were too optimistic”. The response is simple “can you do any better?”. Markets are wrong all the time, but it’s hard to consistently anticipate them, anyone who could do it would be fantastically wealthy. Instead of trying to beat the market, especially deeply traded assets like bonds, currencies, commodities and stock indices, try to read the market.

Other factors—and these may be partly behind the market’s relatively bullish outlook—in favor of a continued runup in NGDP growth include the appointment of a new Fed chair. Given Trump’s peculiar nature, it is hard to imagine him not pushing for maximum concessions for giving Powell the big job.

Maybe prospective Chairman Powell will prove another timid ‘Fedling’ (to coin a diminutive), or maybe he will tack another half percentage point on to the NGDP growth path. We really can’t know, but the possibility of faster growth is enticing and plausible. This is aided by the low inflation record, in which case if the Fed did want to boost the economy; there is ample scope to do so.

The Fed likes to store up low inflation record. If there’s a supply shock, they can run the economy above their arbitrary 2% inflation threshold and their banked low inflation record will give them rhetorical ammunition when their colleges and the commentariat accuse them of being reckless. Regardless of the merits of this approach, it has become a tightfisted absurdity since, with the exception of four months in 2012, the Fed has not hit 2% year-over-year inflation since 2008. Every month that goes by causes the inflation gap (distance of actual prices from a theoretic 2% target line) to widen. Even on the ridiculous metrics the Fed has set up for itself, there is plenty of cover to let nominal growth accelerate to 5%, if the authorities want it to.

This is of course is mere speculation. Our forecast, more precisely our expectation, is for NGDP growth over the next year to be about 4.2%. This is what the models average out to, and a year ahead is about as far as there’s any point in forecasting.

This said, growth has accelerated and 2018 is shaping up to be the most hopeful year for the economy in a long while—forecast risk is to the upside. Unlike in 2014, when a growth acceleration was thwarted by a Fed eager to start raising rates, all the pieces are in place to have a genuine boom, and believe it, if NGDP growth holds at (say) 4.7% for a few years, it will feel like a boom. Markets seem to sense this possibility, and have baked a probability for stronger growth into their implicit forecast.


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