Research

Most accurate economist predicts modest growth in 2014

Things get better -- but not dramatically so -- in 2014, says 2013 Lawrence R. Klein Award winner Dean Maki. For the second half of this year, he sees economic growth continuing at a muted pace, predicting only about 2 percent growth in real GDP thanks to increased fiscal drag weighing down the economy. He forecasts a modest improvement to 2.5 percent GDP growth for 2014. “I’d characterize this as not particularly strong growth,” Maki noted.

2013-11-07

For his accuracy is predicting the direction of key economic indicators in the face of both structural and cyclical changes in the U.S. economy, Dean Maki, chief U.S. economist at Barclays, has been awarded the 2013 Lawrence R. Klein Award for Blue Chip Forecast Accuracy. At a ceremony in New York City on Tuesday evening hosted by the W.P. Carey School of Business at Arizona State University, Maki received the honor and shared his economic predictions for 2014. As winner, Maki bested some 50 other economists who submitted forecasts in four key indicators—gross domestic product (GDP), consumer price index (CPI), unemployment, and the Treasury bill rate—each January in the Blue Chip Economic Indicators newsletter. The Blue Chip newsletter, edited by Randall Moore, who attended Tuesday’s event, has been published for almost 40 years and is regarded as the “gold standard” of business forecasts. This year’s award is particularly meaningful because of the recent passing of its namesake, Lawrence R. Klein, a Nobel Prize-winning economist who is widely regarded as the father of economic forecasting. “All of our winners owe a debt to Larry Klein for his pioneering contribution to econometric forecasting,” remarked Moore. “Before Lawrence Klein, people doubted the usefulness of economists,” added Larry Kantor, Barclays managing director and head of research, who presented this year’s award to Maki. Kantor—who joked that he made the right move in hiring Maki eight years ago—praised Maki for the depth and breadth of the forecasting research he undertook in order to “get it right,” as well as his willingness to go against prevailing economic wisdom. Getting it right, of course, is exactly what Maki did for the years of 2009, 2010, 2011, and 2012. His unemployment and inflation figures were particularly accurate, and his 2012 forecasts really set him apart, noted Research Professor Lee McPheters of the W. P. Carey School of Business. “Maki predicted GDP would rise and unemployment would decrease, and his numeric estimates for those indicators were spot on,” McPheters noted. Maki’s overall average error was just .469 percent. Looking Ahead to More of the Same Given his remarkable accuracy, Maki’s predictions for the remainder of 2013 and 2014 carry great weight. In addition, his insights into underlying forces that are changing the shape of the U.S. economy are worth noting. “The tricky part of forecasting this cycle has been trying to determine what are the impacts of structural elements that are changing in the U.S. economy, and what is the result of the regular recession and business cycle,” Maki explained. For the second half of this year, Maki sees economic growth continuing at a muted pace—he predicts only about 2 percent growth in real GDP thanks to increased fiscal drag weighing down the economy. He forecasts a modest improvement to 2.5 percent GDP growth for 2014. “I’d characterize this as not particularly strong growth,” Maki noted. (Both figures are an improvement over the 1.6 percent GDP growth posted over the last four quarters, however.) Two factors Maki called “major headwinds” account for this prediction. For the remainder of 2013, Maki pins the continued sluggish pace of growth to the impact from cuts in government spending (made worse by the recent shutdown in Washington), and the ongoing impact of the January 2013 tax increases. “Government spending’s contribution to GDP in the second half of this year will be almost as negative as it has been throughout the recovery,” said Maki, pointing to the Federal government sequester as the culprit. While many are quick to question the importance of government spending, Maki disagrees. “Government spending does matter because it is a line item in GDP. So when government spending is cut, GDP growth is going to be slower, at least in near term,” he explained. In addition, consumers faced a tax increase at start of the year, which has had lasting effects. With a roughly 8 percent drop in real disposable income during the first quarter of 2013, it was only a matter of time before consumer spending would slow, Maki explained. As a result, the private sector contribution did not pick up in 2013 the way it has in previous parts of the recovery. “The combination of these two forces is why growth will be soft in the second part of the year,” Maki explained. But with these two headwinds dissipating by 2014, Maki sees prospects brightening, accounting for the increase to 2.5 percent GDP growth. “We think the total fiscal drag on the economy this year was 1.8 percent of GDP. In 2014 it will be only about 0.5 percent, and that is why we think things get better next year,” he explained. Maki also expects inflation to gradually rise in 2014—a situation that he sees as “comforting,” because inflation currently is lower than the Federal Reserve Bank would like. He also predicts the Fed will continue with its asset purchase plan—buying $85 billion per month in securities—until September 2014, and will not raise rates until the middle of 2015. Demographics at Root of Tricky Unemployment Numbers Interestingly—and somewhat counter-intuitively—Maki believes the economy’s continued sluggish growth will still be enough to improve the jobs picture. He places the unemployment rate at a relatively healthy 6.5 percent by the end of 2014. “We maintain the view that that this kind of sluggish GDP growth will be fast enough to keep pushing the unemployment rate down more than the consensus expects at this point—and more than the Fed expects as well,” Maki said. Surprisingly, it seems we now need less economic growth than in the past to push the unemployment rate down. Throughout the current recovery, the country has seen roughly 2 percent GDP growth as well as an increase of some 185,000 jobs per month. Comparatively, in the booming recovery of the late 1990s, the economy grew at 4.5 percent—twice as fast as today—and payroll increases were about 275,000 jobs per month. But the unemployment rate is actually falling faster now than it did in the late 90s when growth was twice as strong, Maki pointed out. “This is evidence that something has changed. We are dealing with something different in the economy than in the late ’90s,” he explained. That “something,” according to Maki, is demographics—specifically, the retirement of Baby Boomers. The labor force participation rate has been on a steady decline since 2000 (with the exception of a brief respite during the housing bubble when wages grew so quickly that people stayed in the labor force when they would have ordinarily retired), because of the large numbers of Baby Boomers who are leaving the work force via retirement. “Simple demographics at work have caused the downward trend in the participation rate over the last decade,” Maki noted. “We believe this impact accounts for about two-thirds of the actual drop in the participation while the other one-third is cyclical.” His explanation goes against the grain somewhat, as does his belief that the unemployment numbers are still an important indicator. “The way we understand it, the unemployment rate is just as meaningful a measurement now as it’s ever been,” Maki said. Detractors, he explained, claim the unemployment report shouldn’t count because it is driven by people dropping out of the labor force—and that these people will come back into the labor force at some point, preventing the rate from falling much further. To Maki, this is an urban legend. “Everyone seems to believe this, but it has never actually happened. My challenge to people with that view is to show me an example in the past of when that has occurred,” he said, noting that job losers, not re-entrants, drive the unemployment rate. Maki shared additional data to support his claim that the structural impact of Baby Boomer retirement has driven much of the change in unemployment rate patterns. The labor force participation rate has fallen 2.7 percent as share of total population from the beginning of the Recession (Q4 2007) to now. Of those additional people who are no longer in the labor force, the number of people who say they do not want a job has risen by 2.2 percent in that same time frame. Furthermore, the largest category of unemployed people who say they do not want a job are the in the 55+ age group—this category increased by 1.7 percent from Q4 2007 to Q3 2013. “The fraction of the population that is 55+, not in the labor force, and don’t want a job—i.e., retired people—has been skyrocketing over the last several years,” Maki explained. “So to us the answer is very clear: what is driving the participation rate down is not people getting discouraged and dropping out of the labor force. It is mainly Baby Boomers retiring the way they were supposed to all along.” Maki stressed the importance of understanding this issue: “We think the path of the unemployment rate is key because it is going to be a major driver of Fed policy. It is going to tell us when the Fed raises rates,” he said. In addition, the fact that the unemployment rate is falling rapidly provides a strong signal that the labor market is tightening significantly. Evidence of that can be found in hourly earnings, which are starting to pick up. “That is what is supposed to happen,” he said. “As we look to 2014, hourly earnings are going to rise further—one of the forces that will push core inflation higher.” All Eyes on the Stock Market The importance of the stock market as it relates to the Fed’s unemployment rate targets as well as consumer spending were other key parts of Maki’s prediction for 2014. Looking back through the last four years, data shows that stock prices are highly correlated with Fed balance sheet activity. “The weekly correlation is .93, so when the Fed is expanding the balance sheet, the stock market is rising,” Maki explained. The correlation worries him, however. “I’m not sure if the Fed can ever stop easing because I’m convinced to get to the Fed’s unemployment rate goals, we need almost an ever-rising stock market,” he said. That’s because models show that today, the stock market is a bigger driver of consumer spending than the housing market. The “wealth effect”—an increase or decrease in spending that accompanies an increase or decrease in perceived wealth—that has resulted from stock market gains has been a powerful force, and one that the Fed is counting on to improve the unemployment rate. But the last two cycles in which wealth effects pushed the unemployment rate to the levels the Fed would like to see today turned out to be asset bubbles, Maki noted. Specifically, the late 1990s stock bubble, and the housing bubble of the mid-2000s. “So the question to consider is whether or not the Fed can get to their unemployment rate goals in this cycle without generating another asset bubble,” Maki explained. “This is a key thing to watch over the next several years.” In addition to these main points, Maki shared a few other key predictions for 2014:

• Core and headline CPI will rise gradually
• Consumption growth will strengthen gradually
• Housing will stay on a solid growth trajectory despite higher mortgage rates
• The U.S. fiscal balance will improve rapidly

Economics Growth & Business Cycles