ECRI's Lakshman: Fed on a Collision Course

Wed, Oct 26, 2016 - 5:10pm

The US has been experiencing a growth slowdown for almost 2 years and, though a recession doesn't appear imminent, ECRI's Lakshman Achuthan says the Fed is on a collision course with the economic cycle.

In a recent interview with Financial Sense, Achuthan, co-author of Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy, explains how demographics and slowing productivity are key to understanding long-term trend growth, something that monetary and fiscal policy may do little to change.

“We’ve been in a growth rate cycle slowdown for almost two years now, where the broad measures of current economic activity, which define the business cycle or the economic cycle...are in a slowdown,” Achuthan said.

Here's a short clip of his recent interview to hear what he had to say:

Where’s the Economy Going Next?

Earlier this year, delayed recognition on the part of investors that we were experiencing a slowdown led to excessive pessimism and the assumption of entering an imminent recession, Achuthan noted. However, those fears were unwarranted and markets bounced back as a result.

Looking at leading indicators currently, the possibilities are that this downturn is going to end up in a recession, with negative growth, or that we get the proverbial soft landing and have growth firm, Achuthan stated.

“Unfortunately, I can’t declare either way,” Achuthan said. “It’s frustrating. We have forward-looking indicators that are not recessionary. I think the one piece of useful news I can preview right now is, a recession is not imminent.”

If a recession were right around the corner, he added, we would see forward-looking indicators declining in a way that would make the economy vulnerable to almost any exogenous, recessionary shock.

Though a recession is very unlikely this year and even in the early months of next year, Achuthan stated, beyond that timeframe, he can’t rule out a recession. There is still a possibility of a recession in 2017, though it’s speculative at this point.

Monetary Policy and Fiscal Stimulus

“For quite some time now, we’ve been making the point that the Fed is kind of on a collision course with the economic cycle and now the inflation cycle,” he said.

This is leading to what Achuthan termed ‘stagflation lite,’ where we can have cyclical upturns in inflation despite slowing growth. This makes rate increases potentially difficult for the Fed, and with limitations on monetary policy, it’s possible we’ll see calls for fiscal policy to step up in response.

However, this ‘Plan B’ fiscal push may not be tenable, Achuthan stated. We’d likely need something around or above $1 trillion to make a difference.

Even assuming we could do that, given our structural issues, and the reasons for weaker long-term trend growth, which basically boil down to demographics — something the government can't really influence — and productivity growth, which has been extremely weak, it may not be enough, Achuthan stated.

“You would have to have a reasonable expectation that your fiscal spending would boost your productivity growth to the tune of two-and-a-half to 3 percent on a sustained basis for the entire labor force,” Achuthan said. “That is a difficult thing to do, even if you have almost unlimited money.”

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