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Post : Not your usual economic forecast: debt levels, demographics and income inequality
URL : http://business.financialpost.com/news/fp-street/not-your-usual-economic-forecast-debt-levels-demographics-and-income-inequality
Posted : January 12, 2018 at 6:00 pm
Author : Barry Critchley
Categories : FP Street

It wasn't your usual economic and financial forecast, but in his first presentation to Canadian clients, Eric Winograd, senior economist at New York-based money manager Alliance Bernstein, devoted considerable time to three secular U.S. trends: rising debt levels, demographics and rising income inequality. Any one of them could derail the U.S. economy’s progress.

“What happens if interest rates rise,” he asked, after noting that while U.S. consumers have borrowed record amounts of debt, the debt service ratios are at near-record lows. “This is a real risk,” he said, noting interest rate changes can be caused by third-party actions, such as the reduced willingness of, say, China to purchase U.S. government securities.

As for demographics, the aging of the population and the reduced percentage of workers in the population “is crashing everywhere,” except India and Africa, both of which wouldn’t be large enough to compensate for the reduced demand from elsewhere. “It’s reasonable to be skeptical,” said Winograd, adding an aging population is associated with slower growth and lower inflation. “That’s the Japan problem,” he said.

Winograd said income inequality is the “one that matters most.” He presented a chart showing the steady rise in corporate profits relative to the slow gains in wages: For the period 1970 to 1992, they moved in parallel, but since then (and even more after 2002) profits have surged.

That pattern “raises risks, the idea of social harmony and that everybody benefits,” he said. “Excellent monetary policy (including quantitative easing) has contributed,” to that inequality, because of the effects on the financial markets, he argued, noting inequality “leads to populism.”

Then there are the puzzles, specifically the still-low inflation rate despite the strong U.S. economy and near full employment. While that pervades at the aggregate level, Winograd delved deeper, by focusing on state and local data to ascertain whether the Phillips Curve — the inverse relationship between unemployment and wage gains — was at work.

For the 13 largest U.S. cities during the period 1997-2017, he was able to generate a graph showing a negative relationship between annual changes in inflation and the unemployment rate. “Cities with lower unemployment have higher inflation,” he said, adding the result isn’t “proof” the Phillips Curve applies to the whole country.

But Winograd also gave a more traditional presentation, in which his base forecast calls for global economic growth of 3.2 per cent — about the same as for 2017 — and for a “gradual increase” in inflation over the course of the year. All of which makes “for a pretty good investment environment,” given that equity and fixed income returns have historically been strong in a high growth/low inflation world.

But that world doesn’t have a “by-the-book” policy response for a central bank. The Fed has raised rates but done it “really slowly and has communicated that it won’t go too far because inflation is low. That will be good enough to allow the environment to persist,” Winograd said, given that the objective is to “extend” the good conditions. He predicts the Fed will raise rates four times this year, one more than what the Fed has conveyed to the market.

Given his view that the U.S. economy “is really strong” — it's led by a robust manufacturing sector, an easing of financial conditions, a healthy small business sentiment and consumer confidence, against the backdrop of a stronger global economy — what will bring the business cycle to an end?

One way is for a gradual tightening of financial conditions that would bring continued high growth but rising inflation. “The environment (starting later this year) will become less favourable from an economic and financial perspective,” he said.


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