Viewpoints

History shows that US growth cycles don't die of old age but are "murdered by the Federal Reserve." Then why has the most significant, in terms of scale, Fed tightening cycle of the past forty years not "murdered" the current growth cycle? The question is complex and challenging to answer, involving many factors. Still, monetary and fiscal policy roles are central to the current growth cycle, making this a compelling study area for analysts and policymakers.

Monetary Policy

The Fed's 500 basis point tightening cycle from 2022 to 2023 stands out as the most significant in scale over the past forty years, surpassing the previous four cycles, which ranged from 175 to 350 basis points. Notably, three of the prior tightening cycles ended in recession, with the 1994-95 cycle being the exception. This time, the economy avoided recession and experienced a growth of over three percent following the Fed's cessation of official rate hikes.

So, has the role of monetary policy in impacting growth cycles changed, or is the policy stance not restrictive to "murder" a growth cycle? The latter.

First, history shows that restrictive monetary policy occurs when official rates are well above the inflation rate. The Fed hiking cycle started with official rates near zero, far below the inflation rate. It wasn't until the middle of 2023, more than a year after the Fed started hiking rates, that official rates matched and then began to exceed what is reported nowadays as consumer inflation.

Yet, it is worth noting that a recent study by economists at Harvard and the IMF found that if inflation was still measured the "old way" (i.e., which included financing costs), reported inflation would have been in the mid-to-high teens. Monetary policy may not be restrictive if actual or experienced inflation is higher than reported. The Harvard and IMF study did not include house prices in its findings as the old CPI did. If house prices replace owners' rents, which are not actual prices, the current reported inflation is still far below actual or experienced inflation.

Economists have developed numerous rules or indicators, such as the Sahm rule and yield curve, to gauge the risk of recession associated with a restrictive monetary policy. However, the housing starts rule stands out for its consistent reliability. It has always succeeded in signaling a tight monetary policy and an impending recession. A substantial decline in housing starts has consistently preceded every recession, and so far, housing starts have not shown a decline associated with stringent monetary conditions. This underscores the importance of considering multiple indicators in economic analysis.

The new tool of quantitative easing is another factor that needs to be considered in the overall stance of monetary policy. Based on the 'stock effect' of quantitative easing, which former Fed Chair Ben Bernanke said is more powerful than the flow effect, QE has offset a significant chunk of official rate hikes, as the Fed balance sheet is still twice the size it was before the pandemic. This underscores the complexity of analyzing the current stance of monetary policy, as the scale of QE needs to be considered.

Fiscal Policy

Fiscal policy is another critical factor when analyzing the current economic cycle. Every dollar the federal government spends goes into someone's pocket, whether a consumer or a business.

The federal government is running a deficit of 6% of nominal GDP. Deficits of that magnitude are rare, occurring during the depth of the recession and never during an economic growth cycle.

When the federal government runs a deficit, it's comparable to when the consumer borrows money to spend beyond its income. Yet, federal government spending is not sensitive to interest rates as it merely borrows more to fund the excess expenditures.

The stance of fiscal policy will only change in two ways: first, if there is legislative action to reduce the pace of spending, or second, if there is a change in tax law requiring consumers and businesses to pay more in taxes to fund the higher spending. Given the 2024 elections are three months away, Congress will not pass any significant spending or tax legislation. And with a new administration taking office in early 2025, it is unlikely that there will be any fiscal restraint anytime soon. The earliest there could be a significant change in fiscal policy stance is when the 2017 tax cuts expire at the end of 2025.

So, when the next recession occurs, it will still be "Made in Washington." However, for now, the combined monetary and fiscal stance policies are too stimulative for a recession to occur and are likely to become even more so if the Fed decides to ease in September.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in June were mixed. Connecticut saw a robust increase of 1.1 percent from May, and Maine rose .7 percent. However, 14 states registered declines, with Massachusetts off nearly .5 percent (obviously some diversity in the performance of New England states!). Over the three months since March, 9 states had increases of more than 1 percent, with Montana up 2.1 percent, but 9 had no change or declines over that period, led by Kansas’s .65 percent drop. The diversity in New England, now localized on the north shore of Long Island Sound, was also evident at this frequency, with Connecticut up 1.9 percent and Rhode Island down .2 percent. Over the last 12 months, Arizona saw an increase of 4.3 percent, with 7 other states up more than 3 percent. However, a full dozen states had growth under 1 percent, and 5 of those saw declines, led by Rhode Island’s 1.2 percent drop.

The independently estimated national figures of growth over the last 3 (.6 percent) and 12 (2.7 percent) months appear to be roughly in line with the state numbers.

State labor markets were yet again mixed to moderate in June, though the number of states with unemployment rates under 3.0% diminished. Eight states had statistically significant gains in payrolls, all in the range of .4 to .6 percent. North Carolina’s increase of 23,100 (.5 percent) was the largest, though California’s statistically insignificant rise of 22,500 was nearly as big.

Eight states had statistically significant increases in their unemployment rates in June and one showed a decline. The increases were no more than .2 percentage point, but Connecticut’s rate dropped .4 percentage points to 3.9%. The highest unemployment rates were in DC (5.4%), California (5.2%), Nevada (5.2%), and Illinois (5.0%). No other state had rates as much as a point higher than the national 4.1%. Alabama, Hawaii, Iowa, Maine, Maryland, Minnesota, Mississippi, Nebraska, New Hampshire, North Dakota, South Dakota, Tennessee, Vermont, Virginia, Wisconsin, and Wyoming had rates of 3.0% or lower, with both South Dakota at 2.0%.

Puerto Rico’s unemployment rate was unchanged at 5.8%, while the island’s job count fell by 900.

Auto and light truck assemblies sprinted 21.1% month-to-month (not annualized) in June to a seasonally-adjust annualized level of 13.1 million units, the highest level of monthly of production since July 2015. In May, retail dollar inventories of motor vehicles (and parts) relative to dollar retail sales of them continued their upward trend, reaching 1.93, the highest since April 2020, when Covid infections were in their early stage. The retail inventory-to-sales ratio of motor vehicles will artificially rise higher in June due to the surge in June assemblies and the curtailment of sales related to the computer hacking of car/truck dealers last month. But discounting the likely increase in the I/S ratio in June because of the hacked software, retail inventories of motor vehicles are starting to look a bit excessive, albeit below the ratio to sales pre-Covid. (See Chart 1 for these data.)

I thought that by 2023 the US economy would have entered a recession. My favorite recession indicators, the yield spread between the Treasury 10-year security and the federal funds rate and changes in real “thin-air” credit, both suggested a recession was imminent. When the yield spread enters negative territory and remains negative for as long as it has of late (see Chart 1), since 1970, a recession has occurred. But not this time. Similarly, when the yield spread persists in negative territory, typically, real thin-air credit (depository institution holdings of loans, securities and reserves deflated by the Gross Domestic Purchases chain-price index) contracts and a recession is underway (see Chart 1). The percent contraction in real thin-air credit of late has been the largest since the Great Depression. But still no recession. It’s been a long time coming, but I do believe the US economy finally stands on the precipice of a recession.

State real GDP growth rates in 2024:1 ranged from Idaho’s 5.0% to South Dakota’s -4.2%. Growth tended to be high in the mountain West and the Southeast. Many highly agricultural states in the Plains saw declines, but Illinois, Ohio, Oregon, and Louisiana also saw drops. Pennsylvania is on the verge of becoming the sixth state with current-dollar GDP exceeding one trillion dollars. The five currently above that threshold are California, Texas, New York, Florida, and Illinois; Pennsylvania’s 2024:1 figure was $998 billion, at an annual rate. No other state exceeds $900 billion.

The distribution of personal income growth was comparable to real GDP. South Carolina first with a 9.5% growth rate, while North Dakota’s .6 % was the lowest. It appears that weakness in farm income held down net earnings in the agricultural regions. As always, the distribution of the growth of transfer payments was erratic and influenced the rankings of total personal income growth, but in this instance, generally slower transfer growth in the Plains merely tended to accentuate the effect of weakness in net earnings. with Nevada again on top with a 6.7% growth rate, while Iowa and North Dakota tied for last with each having a growth rate of 0.8%. Over the last few years, the extension and withdrawal of federal transfers connected to the pandemic often grossly distorted movements in state personal income, and the ranking of states. This has become less evident in recent quarters, though the range of annual growth rates for transfers in 2023:4 did run from 8,1% in Mississippi to -5.0% in Arizona. The large drop in Arizona certainly had a visible effect on its overall income growth; Mississippi’s large gain was less meaningful, since other income components there also grew substantially.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in May continued to be mixed, but a touch improved from the initial April results. Idaho and Arizona led with fairly moderate increases of .6 percent from April, while Arizona, West Virginia, and New Hampshire also had gains above.5 percent, but a full ten states, scattered across the nation, saw declines, with Rhode Island down .4 percent. Over the three months since February, 11 states had increases of more than 1 percent, with Montana up 2.4 percent. 15 states had gains under .5 percent, with 3 of those experiencing declines. Over the last 12 months, Arizona was on top with a 4.1 percent increase. There were six other states with increases higher than 3 percent. On the down side, four states (none large) had declines, with West Virginia off 1.8 percent (Montana was off 1.4 percent, despite its strong April), and 9 others had increases of less than 1 percent.

The independently estimated national figures of growth over the last 3 (.7 percent) and 12 (2.8 percent) months appear to be roughly in line with the state numbers.

State labor markets were again mixed to moderate in May. Seven states (counting DC here) had statistically significant gains in payrolls , with the most impressive gain Idaho’s .9 percent increase, while both California and Texas had increases over 40,000 The other states, had changes deemed to be insignificant, including New York’s increase of more than 20,000.

Four states had statistically significant declines in their unemployment rates in April, and three had increases. None were larger than .2 percentage point. The highest unemployment rates were in DC (5.3%), California (5.2%), DC (5.2%) and Nevada (5.1%). No other state had rates as much as a point higher than the national 4.0%. Alabama, Hawaii, Iowa, Kansas, Maine, Maryland, Massachusetts, Minnesota, Mississippi, Nebraska, New Hampshire, North Dakota, South Dakota, Tennessee, Utah, Vermont, Virginia, Wisconsin, and Wyoming had rates of 3.0% or lower, with both Dakotas at 2.0%.

Puerto Rico’s unemployment rate was unchanged at 5.8%, while the island’s job count edged up by 700.