New Policies, New Path

Back in the 1970s, supporters of the status quo said there was nothing to be done about stagflation (high inflation and slow growth). It was a "fact of life" that Americans had to accept after experiencing faster growth and lower inflation during the decades immediately following World War II.

Then, along came the supply-side and monetarist economists with new ideas about how the "policy mix" mattered, that marginal tax rates affected the incentive to work and invest and that the supply of money helped determine inflation. Simple ideas, in retrospect, but decried as radical notions at the time by supporters of the stagflation status quo. Supply-side economics was dismissed as "voodoo economics."

Similar arguments have come back into vogue in the past decade, with apologists for slow growth arguing the US simply can't grow as fast as it used to. "Secular stagnation" means growth will be permanently slow. Rapid growth, they claim, is a thing of the past.

In the 1980s, when supply-side policies were tried, they worked. Growth picked up, inflation fell. Now, the U.S. is going through another major shift in the "policy mix," with the federal government focusing on deregulation and tax cuts. In a nutshell, we've gone from a political philosophy that said "you didn't build that" to one that says "please build that."

As a result, expectations about the economy are changing rapidly. The Atlanta Fed is now projecting real GDP growth at a 5.4% annual rate in the first quarter, which would be the fastest growth for any quarter since 2003. We think that's on the optimistic side and expect growth at more like a 4.0% annual rate, but, either way, the economy is showing signs of an overdue acceleration and we are now projecting growth of 3.5% for 2018 (the fastest "annual" growth since 2003).

Friday's jobs report brought news that wages are now accelerating as well. Average hourly earnings grew 0.3% in January and are up 2.9% from a year ago. Some analysts said wages were probably lifted in January due to unusually bad weather, which was also the culprit behind the drop in the number of hours worked for the month.

It is true that the number of workers missing work due to weather was the second highest for any January in the past 20 years. But we've had other months with nasty weather since 2009, and this is the first time since then that wages were up 2.9% over a twelve-month period. Meanwhile, jobs increased 200,000 for the month, so we doubt bad weather was the key trigger.