U-M forecast: U.S. economy to start slowing, deficit and workers' wages to rise

JC Reindl | Detroit Free Press

The U.S. economy will grow a little slower in 2019 as the immediate effects of the recent deficit-widening tax cuts wear off, although workers will enjoy better wage growth into 2020, according to the University of Michigan's annual economic forecast released Thursday.

The forecast by U-M economists anticipates 2.7 percent year-over-year GDP growth in 2019, below the 3.3 percent average pace of the first three quarters of this year.

The Republicans' tax overhaul, which took effect in January, was largely responsible for this year's exceptional GDP growth that is expected to run 3 percent for the full year.

Yet the forecast refers to this boost as a "budget-deficit-fueled high" that will ultimately push the federal deficit into uncharted territory.

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As the tax act's stimulus effect on the economy wanes, growth will downshift and eventually fade to 1.9 percent GDP for 2020, the forecast predicts.

"So whatever (growth) we are getting from that, it is probably going to be over shortly," said Daniil Manaenkov, one of the five U-M economists who produced the forecast.

The nation's economy also will enter a period of fragility once the tax act's stimulus effects fade in mid-2019, the forecast says, and then will be increasingly vulnerable to any external shocks or policy mistakes. This is when a recession becomes "a real possibility," the forecast says.

The U-M economists stop short of predicting when the next recession will hit. Their forecast stops at the end of 2020, when they predict that GDP growth will have cooled to 1.4 percent that fourth quarter.

However, the economists do cite what they consider the "early warning signals" for when a recession is about to hit: falling new home sales, falling short-term interest rates, slowing job creation, a jump in unemployment claims and a decline in heavy truck sales.

"Calling a recession in real time remains notoriously difficult in the economics profession, but not for lack of trying," the forecast says.

Wages going up

The forecast contains good news for workers.

Average per-hour compensation will have experienced 3 percent year-over-year growth in 2018, and will hit 3.7 percent growth next year and a solid 4.4 percent in 2020, the forecast says.

These pay raises would result from a tightening labor market as more baby boomers retire, which would put upward pressure on worker pay and benefits. The national unemployment rate is forecast to fall to 3.4 percent by the end of 2019 and stay at that level through 2020. Unemployment stood at 3.8 percent in the third quarter of this year.

Of course, inflation is expected to eat into some of workers' wage gains.

The forecast anticipates "headline inflation" (which counts food and energy costs) as being 2.5 percent this year, then slowing to about 2 percent in 2019 and 2020 as oil prices stay essentially flat.

Blown-out deficit

A growing economy usually leads to smaller budget deficits. But that isn't happening in the United States in large part because of the tax overhaul, which is costing the federal government more money than it is bringing in and blowing out the deficit to a projected $925 billion for 2018, up nearly 40 percent from last year.

The deficit would jump to $1.1 trillion in 2019 and $1.2 trillion in 2020, when the country's debt-to-GDP ratio would hit 71 percent, according to the forecast's methodology.

It's an open question whether those big deficits will matter.

Manaenkov noted how Japan has been running a debt-to-GDP ratio that is more than double that of the United States, yet Japanese interest rates have stayed low.

Still, high debt levels can eventually lead to higher interest rates — and slower GDP growth.

Exactly when deficits and debt become problems for a country like the United States is a subject of debate among economists.

"It is not entirely clear where is the threshold where debt becomes a problem," Manaenkov said. “But that level for the U.S. economy is fairly high."

The national economic forecast also says:

Total light vehicle sales will decline to 16.9 million units in each of 2019 and 2020 as interest rates rise and the economy cools. (Those sales are projected to be 17.1 million units for all of this year.)

The cars segment of the autos market will continue to decline into 2020.

New tariffs have had only a modest effect so far on the U.S. economy.

Home prices appreciation has slowed and is likely to continue decelerating.

U-M's Michigan-specific economic forecast is scheduled to be released Friday.

Contact JC Reindl: 313-222-6631 or jcreindl@freepress.com. Follow him on Twitter @JCReindl.