Economic Forecast 2018-2019: Demand Is Strong But Supply Is Weak

My economic forecast comes out to 2.7 percent growth in inflation-adjusted GDP for this year and 2.8 percent for next year, but with a bigger than usual uncertainty: can we actually produce more stuff with our current labor force and productivity?

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Economic Forecast 2018-2020

Most economic forecasting models are demand-based: they focus on spending. The supply potential of the economy is frequently ignored, and that’s frequently the correct assumption. But not now.

If every person and machine were already working flat out, then increased demand would not increase output. It would only raise prices. Usually, though, there’s plenty of slack among both people and physical capital that we can boost production, if only demand is there. But with unemployment below four percent, I’m worried about the supply constraint.

My economic supply model boils down to two drivers of output: labor force and productivity. (There are additional details not important right now.) Recent trends suggest GDP growth of about 1.7 percent—a long way from my 2.7 percent forecast.

Details of the supply-side forecast: The employment/population ratio continues to increase at the same pace as in the 2011-2017 period. This may be optimistic, given that over this period unemployment dropped over four percentage points. From its current level of 3.8 percent nobody expects another four points of decline. What could make this prediction come true is increased labor force participation. I assumed that population of working age continues growing at its recent low pace. Average hours worked per worker has no long-term trend; it is a temporary adjustment factor, so I put the change at zero. Finally, I used productivity growth’s average from 2011 to 2017.

My supply forecast appears to be a limitation on economic growth, but supply and demand do not work in isolation from one another. In particular, the availability of jobs will bring people out of the woodwork. Many people will work through discouragement, minor pain and family challenges when a good job is available. Productivity will also grow faster as businesses use robots, machinery and software to substitute for those hard-to-find employees.

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