THE U.S. ECONOMY REMAINS ROBUST: Is a Recession Coming in 2019?

• Author: Sonora, Robert
• Position: TRENDING

The U.S. economy continues to move into positive territory. For the first quarter of 2019, real GDP in 2012 prices was about $18.9 trillion after a healthy year-on-year growth of 3.2 percent. Plus, the national unemployment rate is at a near historic low of 3.6 percent, about 1 percent below the Congressional Budget Office's estimated level of full employment. We are also experiencing an extraordinary period of stable and low inflation.

Figure 1 shows both the unemployment rate and inflation using the price of consumer expenditures without food and energy (core inflation), which is the preferred price index by the Federal Reserve.

There appears to be little relationship between the two series. This is notable because until recently policymakers based their decisions on the negative relationship between inflation and unemployment. In economics, the Phillips Curve states that inflation and unemployment have a stable and inverse relationship. For instance, if inflation gets too high, the Fed will put the brakes on the economy by raising interest rates, but at the cost of higher unemployment or vice versa.

However, the weakening of the Phillips relationship does give the Fed more flexibility in terms of policy decisions. This is partially due to average labor costs and productivity, which have remained low and steady since the end of the Great Recession, keeping inflation in check.

The growth of wages leveled off between 2013 and 2015, growing at 1 percent after an average growth rate of zero percent from 1987 to 2011. The argument for the Phillips Curve is that as unemployment gets lower, firms must offer higher wages to either entice potential employees into the labor force or to attract higher quality labor from other employers.

But the labor market may not be as tight as statistics suggest. U6 unemployment, which includes discouraged workers, marginally attached workers and workers who work part time but want to work full time, remains above 7 percent.

The output gap is defined as the percentage difference between current real GDP and potential long run real GDP. It currently sits at 0.85 percent. One of the primary reasons for this is the Tax Cuts and Jobs Act, which was passed in 2017, a Keynesian stimulus deficit spending package. This is the type of policy required when an economy is experiencing a recession to reduce unemployment and generate some inflation.

Since the end of 2018, government expenditures have been rising at an average...