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The Economic Forecast for 2018: Better than 2017

By Elliot Eisenberg, Ph.D.
Source: Solutions, Winter 2017

Despite more uncertainty than usual emanating from Washington, D.C., 2018 is shaping up well. The odds of a recession are very low – about 15 percent – even with being in the middle of the third-longest economic recovery in U.S. history. Growth is picking up across much of the planet; commodity prices are well in check; inflationary pressures are weak; and corporate investment in plant equipment is steadily rising.

Tax Reform

Tax reform will be the most important fiscal policy issue of the next few months. While final details are elusive, the proposed cut in the corporate tax rate from 35 percent to 20 percent, the creation of a new 25-percent tax rate for “pass through” businesses, and a one-time tax rate of 14 percent tax on repatriated earnings, are bold. Since the Trump administration is also proposing reductions in individual income tax rates – coupled with the possible elimination of the alternative minimum tax and the inheritance tax, full expensing for business investments and more – the key is how much of this large, costly and mostly unpaid for agenda gets passed.

These tax cuts, totaling $1.5 trillion, net of offsetting tax increases, should raise near-term GDP by a quarter point but not much more as the economy is already near full employment. As a result, the Fed likely will raise rates slightly more quickly than would otherwise be the case. This will be done to protect the economy from overheating and proactively prevent inflation from rising faster than 2 percent/year.

Infrastructure Spending

As for infrastructure spending, despite repeated discussions between the administration and Congress, there is no legislation ready to become law. As a result, even with continued interest, infrastructure negotiations will be put off at least until Congress votes on a tax cut sometime in late 2017 or early 2018, and more likely until the next Congress convenes in early 2019. Assuming quick legislative passage at that point, which is far from guaranteed, the economic impacts are unlikely to be felt until 2020.

GDP growth in 2018 is expected to be 2.40 percent, up from 2.10 percent in 2017; unemployment will decline from the current rate of 4.2 percent to as low as 3.8 percent; and inflation, as measured by the CPI, likely will rise from about 2 percent now to close to 2.4 percent by year-end 2018. Thus, expect the Federal Reserve to raise rates at least three times in 2018, each time by a quarter- point, to prevent the economy from overheating. Also, 10-year Treasury rates likely will increase from the current 2.40 percent to 2.80 percent.

Worker Shortage

The worker shortage will, regrettably, worsen. Employer surveys show firms in an increasing number of industries face growing difficulty in recruiting skilled workers. With unemployment at almost 4 percent, firms will continue to struggle to find employees and will increasingly be forced to turn away some work due to a lack of skilled labor. With U.S. population growth and immigration both slowing, this problem is likely to persist.

Construction Growth

Partly because of the labor shortage, single-family housing starts will rise by no more than 6 percent in 2018, while multifamily activity should, at best, flatline. Remodeling activity looks to grow by a strong 7 percent year-over- year on the back of rising home prices and limited inventories, which are causing homeowners to remodel rather than move.

Regarding commercial and institutional construction, growth heading into 2018 looks soft. Year-to-date, nonresidential building is up less than 5 percent.

On the commercial side, leading the way is hotel/motel construction and warehouses, both of which are up over 30 percent. As for institutional activity, leading the way are police and public safety construction, which is up almost 50 percent, and religious building construction, which is up 30 percent. Other areas with gains include nursing and assisted living facilities, as well as library and museum construction, both of which are up by 15 percent. These trends are unlikely to change markedly in 2018 except for an anticipated slowdown in the lodging sector.

In summary, 2018 looks to be slightly better than 2017 due to solid and synchronized global growth. Passage of the proposed Republican tax cuts will aid the economy but less than many expect due to already very low levels of unemployment. A bit of a wildcard are the ongoing NAFTA negotiations with Canada and Mexico. A dissolution of the pact would weaken growth, albeit not substantially. Lastly, while interest rates will rise in 2018, the increases will be measured, and the chances of a recession are very low.