GSU Economist Urges Patience as Full Impact of Tax Cuts Ripples Through System

by Camren Skelton

ATLANTA — With the full effect of the tax cuts yet to be felt, any talk of a recession is ultimately premature, according to Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University’s (GSU) J. Mack Robinson College of Business.

Speaking at his quarterly economic forecast, which was held on Wednesday, May 23 at GSU’s Centennial Hall Auditorium, Dhawan said the impact of the Tax Cuts and Jobs Act signed into law by President Trump last December should take hold by the middle of this year.

In addition, he expects the Federal Open Market Committee (FOMC) to raise the federal funds rate, the overnight interbank lending rate, twice more in 2018: once in June then again in December. The current federal funds rate is 1.75 percent.

In the interim period between those two hikes, the forecaster expects the Fed to keep a close eye on two key trends: consumer spending and long-bond yields.

“First, evidence has to emerge that tax cut-induced consumer spending is finally taking hold as weak retail sales numbers in the first quarter were a snapback from a hurricane rebuilding spending surge in the last quarter of 2017,” Dhawan wrote in his quarterly Forecast of the Nation, which was released Wednesday.

Total retail sales increased 0.2 percent in the first quarter of 2018, falling from the 2.7 percent quarterly increase in fourth-quarter 2017, according to the U.S. Department of Commerce.

Although consumers have already begun to experience the tax cuts in their paychecks, the impact hasn’t fully registered, explained Dhawan.

“People don’t pay close attention to their paychecks, so it’s going to take some time before people realize they have some extra money,” said Dhawan. “And right now the extra money is getting kicked in a little by soaring gas prices.”

As of Thursday, May 24, the average price for gasoline nationally was $2.96 per gallon, according to AAA. That’s the highest price point going into Memorial Day weekend since 2014.

A Global Economy
The second reason Dhawan believes the Fed will wait six months between hikes is to allow the factors that determine a rise in long-bond yields to play out.

“What happens to the long-bond yield as the Fed hikes rates is key,” he wrote in his forecast.

Long-bond yields are determined both by global capital flows and the domestic debt issuance in response to the federal fiscal deficit. The 30-year Treasury yield closed on Tuesday, May 22 at 3.21 percent, an increase of 47 basis points from the start of the year.

Given the recent budget passage of spending increases and the tax cuts signed into law by President Trump, Dhawan expects the issuance of Treasury bills to rise abruptly in the coming quarters.

While other forecasters and members of the media are signaling that an inverted yield curve — which could lead to a recession — is looming, Dhawan believes the Fed can keep these concerns at bay. An inverted yield curve is an interest rate environment in which yields on short-term debt are higher than yields on long-term debt.

Dhawan expects gross domestic product (GDP) to grow by 2.9 percent in 2018, and then moderate to 2.4 percent next year and 1.8 percent in 2020. But that prediction has a caveat — no major trade wars or skirmishes in the coming quarters.

“Expansions don’t come to an end by themselves,” said Dhawan. “Expansions come to an end either because the Fed is fighting the demon of inflation, or you have an outside shock that comes and knocks the system off its trajectory.”

According to Dhawan, the biggest impact of trade actions is their impact on global capital flows.

“If tariffs on our major trading partners, especially China, drive them out of the U.S. Treasury market, it will make 10-year bond yields rise in three months. In a normal forecast, that would happen in three years.”

If such a scenario occurs, Dhawan says all bets on his “soft landing” forecast are off.

“But forecasting the probability of a trade war is more dependent upon political calculations than economic logic,” Dhawan wrote. “Thus, we aren’t forecasting it, but cannot deny this as a potential outcome.”

Other predictions included in Dhawan’s national report:

  • The average monthly increase in nonfarm payroll employment will be 180,200 in 2018, 158,700 in 2019 and 111,800 in 2020.
  • Housing starts will average 1.29 million units in 2018, fall slightly to 1.26 million in 2019 and rise again to 1.3 million units in 2020.
  • Auto sales will be approximately 17 million units in 2018 before dipping to 16.2 million in 2019 and 16 million in 2020.
  • The 10-year Treasury yield will average 3.2 percent in 2018, 3.9 percent in 2019 and 4 percent in 2020.

— Camren Skelton 

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