Not your nor­mal eco­nomic fore­cast

In­come in­equal­ity ‘raises risks’

National Post (Latest Edition) - - FINANCIAL POST - Fi­nan­cial Post bcritch­ley@ na­tion­al­post. com

It wasn’t your usual eco­nomic and f i nan­cial fore­cast, but in his first pre­sen­ta­tion to Cana­dian clients, Eric Wino­grad, se­nior econ­o­mist at New York­based money man­ager Al­liance Bern­stein, de­voted con­sid­er­able time to three sec­u­lar trends: ris­ing debt lev­els, de­mo­graph­ics and ris­ing in­come in­equal­ity. Any one of them could de­rail the 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 U. S. 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 19972017, 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 eco- nomic 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 U. S. 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 small­busi­ness 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 still high growth but ris­ing in­fla­tion. “The en­vi­ron­ment (start­ing later this year) will be­come less favourable from an eco­nomic and fi­nan­cial perspective,” he said.

Barry Critch­ley

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