Economic growth slows, but poised to take-off to reach 4% by year end
WASHINGTON: Economic growth slows in the first quarter of 2018, according to the Commerce Department. Their first estimate of first-quarter growth was 2.3%. This is down from 2.9% in the prior quarter. Although the number was higher than expected, it is below the 3% level that President Trump promised.
An economy poised for take-off
The first quarter number is not a true reflection of economic activity, mostly because consumer spending was weak. But the weakness was in January and February. Once consumers felt the effects of the tax cut by late February, consumers increased spending in March by .6%.
That’s about a 7% annual rate. And consumers account for 70% of GDP.
Most economists expect the economy to start growing at least at a 3% annual rate in the current quarter. Some economists think growth will accelerate to 3 1/2% or higher by the end of the year. A 4% rate is not out of the question.
An economy based on increases in spending
The reasons are simple: every sector of the economy should see increased spending. That means the consumer, business, government, and foreign sectors will all grow. The potion of the tax cut geared to the middle class will mean consumers have more to spend. That’s what happened in March and will continue to happen throughout the year.
The business sector should also increase investment spending. Since the corporate tax rate was reduced from an average of 35% to 21%, corporations will now have more net income. That will provide new funds for them to increase investment.
But some economists argue that investment may not substantially increase.
Will Corporations provide new economic growth?
Those economists say that corporations will use much of the new income to increase dividends and/or buy back some outstanding shares. That means the corporations will not increase investment.
That is true, but….
Even if corporations increase dividends or buy back shares, the funds will still likely result in increases in investment. That’s because the recipients of the dividends and buybacks will simply invest the money into other corporations which have better investment opportunities.
If a company does not have good investment options, they should increase dividends. That will allow the stockholders to invest the funds where better opportunities exist. An investor selling stock back to a corporation does so because better investment opportunities exist elsewhere.
The bottom line is that the reduction in corporate taxes will lead to an increase in business investment.
Government spending will also increase.
The federal government just passed a $1.3 trillion discretionary spending budget. That represents about a 10% increase in discretionary government spending. That money will further stimulate economic growth.
Because the president is re-negotiating poor trade deals, exports will increase and imports will fall. This too has a positive effect on growth, although there may be some negative impacts if the new deals take time to finalize.
That means all four sectors of the economy are now poised to have positive effects on economic growth.
There are some headwinds even as economic growth slows
While the groundwork has been put in place for the best year since 2005 for growth in GDP, there are some potential problems. The Federal Reserve is raising interest rates. In 2017, rates were raised three times. In 2018, they could be raised up to four times. Normally that would really slow economic growth. This time, it is not likely.
That’s because even with the increases, rates are still historically low. For instance, mortgage rates have increased from the low 3% range to the upper 4% range. History shows that the housing market is usually strong when mortgage rates stay below 6%. Even with Federal Reserve’s actions, we are still probably 3 to 4 years away from 6% mortgage rates.
Winds of Trade Wars
A trade war could be a problem. That could lead to fewer exports and rising prices for imports. But a trade war is also unlikely. Trump is simply creating a sense of urgency in order to bring our trading partners to the negotiating table.
Trump recognizes our free trade agreements simply aren’t fair and favor the other countries. Instead of waiting years to resolve that, he wants it resolved immediately. By imposing tariffs to create a sense of urgency, he brought the other nations to the bargaining table.
Inflation could also be a problem. Rising energy and commodity prices could push up consumer prices. Fortunately, Trump has removed counter-productive regulations and opened up land for drilling. The US can now increase energy production enough to keep prices in a reasonable range.
At the end of July, the Commerce Department will release their estimate for second-quarter growth. The consensus view is that it will be at least 3%. By the end of the year, our economy could be growing at a 4% rate and that rate could last some years into the future.
That’s what happened after the similar Kennedy/Johnson tax cut in 1964 and the Reagan tax cut in 1982. And that’s what will happen this time too.
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