Editor’s note: This report is a condensed version of Northern Trust Corp. chief economist Paul Kasriel’s 2011 Economic Outlook.
There are some significant changes to key variables in this month’s forecast compared with the November 2010 forecast.
With regard to 2010 real GDP growth, we now expect Q4/Q4 growth of 2.9 percent vs. 2.3 percent in the November forecast.
Based on Q4:forecast and 2010 available data, real GDP appears to be coming in at an annual rate of 3.6 percent rather than the 1.9 percent we were projecting in November. In addition, the Commerce Department revised up Q3:2010 real GDP growth from 2.0 to 2.6 percent.
With regard to 2011 real GDP growth, we now expect Q4/Q4 growth of 3.3 percent vs. 3.0 percent in the November forecast.
An upward revision of 2011 Q4/Q4 real consumption growth to 2.9 percent from 2.5 percent in November is the primary factor accounting for the upward revision to the real GDP growth forecast.
We are more optimistic about 2011 real GDP growth primarily because QE2 implies that the Fed will be purchasing all of the additional Treasury debt issued in conjunction with the Obama-McConnell tax and unemployment insurance compromise. We currently see more upside risk to our 2011 real GDP growth forecast than downside risk.
Consistent with the upward revision to our 2011 real GDP growth forecast, we also have lowered our forecast for the level of the unemployment rate and raised our forecast for the CPI inflation rate.
We do not expect the Fed to raise any of its policy interest rates until early 2012. Given our assessment of upside risk to our 2011 real GDP forecast, however, we also would assign increased risk to an earlier Fed move on policy interest rates.
Other highlights:
- The pace of economic activity is expected to accelerate in 2011 on a Q4/Q4 basis largely because of increased growth in credit created by monetary financial institutions.
- Housing and state/local governments are sectors that will remain a drag on economic growth.
- Exports are and likely will remain a star performer of the U.S. economy.
- Inflation, while remaining low in absolute terms, is expected to increase modestly.
- Money market interest rates are anticipated to remain near current levels because the Fed is not expected to raise its policy interest rates in 2011.
- Bond yields are expected to drift higher as real bond interest rates continue to “normalize.”
- The principal upside risk to economic growth and interest rates is that private monetary financial institutions sharply increase their credit creation.
- The principal downside risk to economic growth and interest rates is that Chinese economic growth decelerates sharply.
- Federal budgetary issues are not a near-term threat to economic growth, but are a long-term threat.
- Assuming continued relatively strong economic growth in the developing economies, discretionary incomes will be rising for hundreds of millions of households. This will provide export opportunities for U.S. in the areas of agricultural, health care technology/pharmaceuticals, infrastructure, fast food, retailing and entertainment.
- With real economic growth expected to accelerate in 2011 and Fed interest rate hikes anticipated in early 2012, the real bond yield is expected to drift higher toward its average level of 1.86 percent of the past 11 years.
- The U.S. Federal budget is more of a long-term headwind to economic growth than a short-term headwind.
- Milton Friedman taught us that when the government spends it also taxes – either explicitly today or implicitly tomorrow. So government spending is the real economic issue, not how the government funds its spending.
- With the U.S. economy expected to grow faster in 2011 and with corporations holding large amounts of liquid assets, corporate bond default risk would be expected to diminish. In contrast, with the severe operating budgetary and public pension challenges being faced by state and local governments, municipal bond default risk would be expected to increase.
What are the implications for future real U.S. economic growth if federal entitlement-program spending is not reduced from its projected levels?
- An increased amount of economically-productive resources would be used to care for U.S. retirees.
- Given the finite supply of economically-productive resources, other sectors of the economy would be deprived of the use of these resources.
- Investment in the state-of-the-art equipment/software and R&D by U.S. businesses would be curtailed, adversely affecting labor productivity.
- Resources would be curtailed for education, which will adversely affect the productivity of future workers.
- With current and future labor productivity growth adversely affected, the U.S. economy’s long-run rate of growth would be adversely affected.
