The right time to expand the deficit even if debt stays stable?

The Week Ending Friday February 16th 2018

Bill Dudley called well the February wobble the week before last – small potatoes. The stock market recovery was underpinned by more “even better than expected” company results. The initial run of “even better than expected” company results had let to a severe overshoot in the S&P500 – until a supposedly good January wage growth figure spooked markets into thinking the Fed may tighten even faster.

In addition, the quite generous fiscal spending deal and prospects for an even more generous longer-term spending plan, allied to the already agreed tax cuts, are worrying markets.

Are the Trump tax and spending really plans so disastrous?

The government deficit supposedly could really begin to balloon according to Trump and GOP critics. Well, some of the figures I have seen suggest a 5% growth in total debt ($1tn per annum added to $20tn stock of debt). Not exactly a ballooning of debt and certainly no problem if nominal growth can reach 5% or more. Relative to GDP the total debt would then stay stable. So no big deal.

But, can the Fed ensure nominal growth at 5% or above? We just don’t know if it is even interested, obsessed at it has been with a 2% inflation target (aka ceiling). Our NGDP Forecast shows nominal growth at nearly 4.5% 12 months ahead, having bounced around quite a bit over the last two weeks.

Perhaps more concerning is that the deficit is growing and debt only staying stable at what may be the best time for economic growth. Governments should strive for counter-cyclicality in their spending, holding back when times are good and boosting it when times are a bad. The big question is whether times are good, bad or indifferent. Our NGDP Forecast suggests things are OK but not great, yet. Sure unemployment is low but so is labor force participation and average weekly earnings growth – both nominal and real.

Two questions: What will the Fed do with rates? Will it be loosening or tightening?

The Fed may yet raise rates faster than expected but we just don’t know if that will be a “tightening” – two separate questions.

Higher rates tend to be associated with loose monetary policy, and vice versa. Currently, we know little of new Chair Powell’s views on achieving healthy nominal growth. In two weeks, he will give several hours of testimony to Congress. Little may come of it given the little knowledge his questioners have about economics, especially monetary economics.


This week there have been some encouraging signs from surveys of a further acceleration in economic activity. The NFIB Small Business Optimism Index for January jumped back up to near the November 2017 record high. The February Bloomberg and UMich Consumer Confidence surveys hit new highs.

In contrast, the hard data has been less positive. January Retail Sales growth fell sharply back while the January Manufacturing Production index was flat. Perhaps it was the cold weather. Unlikely, Industrial Production (i.e. Manufacturing plus Energy & Mining) showed negative month-on-month growth.

The arbiter of these differing current indicators, the nowcasts for 2018Q1 from the Atlanta and NY Feds’ both fell back to more like consensus real growth of 2.5% RGDP growth QoQ annualised. Again, OK but not great.

Next week little hard data, mostly surveys and several FOMC Member speeches.


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