In the Press Conference following the FOMC meeting yesterday, Fed Chair Powell referred to what has recently come to be known as “core” GDP: Final Sales to Private Domestic Purchasers (FSPDP). He mentioned that its persistent strength justified probing more carefully (i.e., slowly) downward to find the so-called neutral funds rate.
Whether thinking in terms of the neutral funds rate is appropriate is a separate discussion. But let’s redefine what Powell calls “neutral” as where he thinks the terminal funds rate for this episode might be. Theoretical neutral does not enter into it, for many reasons, one of which is that the funds rate spends little time at neutral. But we all know what he means. If he expresses confidence that neutral is lower, then Powell plans on going lower, and vice versa.[1]
Powell’s Core GDP
Source: BEA, NBER, FH calculations and estimate
Data are actual to Q3 and estimated to Q4.
With this morning’s second revision to the third quarter National Accounts, the rate of growth of FSPDP was revised from 3.2% (ar) to 3.4%. This upward revision was driven roughly equally by upward revisions to PCE and private investment, inclusive of housing. Based on my tracking of real PCE and the Atlanta Fed’s current guess for the rest, I figure that FSPDP is on track to be up at a rate of about 2 ½% during the fourth quarter. That would leave the 2-quarter growth rate just marginally below the 3% pace, around which it has oscillated in a narrow range for the past two years.
With the supply side of the economy likely now getting slightly less strong, as the earlier immigration surge abates, there should be a natural tendency for realized demand growth to follow potential-demand growth lower, even without any impetus from financial conditions. But the case for a shift to below-potential growth seems unconvincing, although Powell continues to reference it, primarily by invoking prospective weakness in hiring. So far, he has been wrong about this, although hiring itself has downshifted and the employment / population ratio has fallen. If anything, I overstated how these developments would affect Powell’s commentary yesterday.
Separately, no inventory overhang
Changing subjects now, the data just released suggest that the flow of inventory investment slowed from $ (2017) 72 billion in Q2 to $58 billion in Q3, delivering a negative 20 basis point hit to GDP growth (which is excluded from the FSPDP calculation, by design). Looking forward, the important point here is that the flow of inventory investment remains very close to the “normal” pace implied by the presumption that the I/S ratio continues its gentle descent and that final sales of goods and structures runs at a normal pace. My estimate of “normal” here — $62 billion — might be off by $20 billion. But that is peanuts compared to the cyclical variability in the flow of inventory investment. The far more important point is that it is the inventory flow that is mean reverting around normal and not the I/S ratio. A spike in the I/S ratio is often followed by a huge impetus from inventories, although I need not get into why here.
Up-&-down economists often let slip otherwise but you may be confident that they are wrong when they do so. For whatever it is worth, the I/S ratio looks depressed, so this would not be an issue even if those wrong economists were not wrong. But looking at it correctly, there is no obvious imbalance on the inventory side, in the Q3 data or as implied by the consensus view that inventory investment quickened marginally in Q4. From here, the flow of investment seems as likely to quicken as decelerate.[2]
Not currently an issue either way
Source: BEA, FH calculations
Data are actual to Q3, although little will have changed during Q4.
[1] We can think of the “short-run” neutral as being a function of the cyclical position of the economy and the mapping of the funds rate to financial conditions. But in that case, we should just watch the cyclical position of the US economy and financial conditions. And this is what the Fed in fact does, which is why they are backing away from signaling significantly further rate cuts even though the theoretical neutral that they occasionally quantify has not moved much. Neutral cancels out of the algebra here, which is why Ockham would say don’t obsess over it. The bond market needs an estimate of neutral. Indeed, the market is a permanent state of updating that estimate. But the idea does not guide actual Fed rate decisions.
[2] Up-&-down economist is a term of derision invented by Paul Krugman. You call one in to go on the TV to say why the market went up or why it went down. It is aimed at my ilk, but I think the term is wonderful.
