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14 8 percentage points if the forecast is correct. In addition to raising policy interest rates, the Federal Reserve will be reducing its balance sheet – unwinding quantitative easing. In the wake of the financial crisis, the Federal Reserve's balance sheet swelled from $900 billion to $4.5 trillion. The Federal Reserve is likely to continue to allow a proportion of maturing assets to roll off its balance sheet. Ultimately, the Federal Reserve's balance sheet will shrink to about $3.0 trillion, but it is taking a while to get there. Crude Oil Markets Absent significant supply interruptions or additional price premiums due to increased political tensions it is likely that oil prices will decline from recent peaks to about $65 per barrel. That is well above the approximate breakeven price for U.S. shale oil production, which will cause U.S. shale oil and other marginal producers to ramp up additional production in 2019. Before Saudi Arabia, Iran, and Iraq decided to defend their market share by flooding the market, oil prices were about $100 per barrel. Because oil markets are so volatile, a significant supply interruption would cause oil to trade significantly higher. There is no shortage of potential negative supply shocks. This forecast assumes a moderate deceleration in the pace of global economic growth and no major disruptions in the supply of crude or refined products. Productivity In this economic cycle, a major barrier to faster U.S. GDP growth is below-average productivity growth. Faster productivity growth would raise wages and living standards. In 2019, the pace of productivity growth will increase only slightly. Since the Great Recession ended, there has not been very much capital deepening – adding more capital per worker. That might change. In 2019, the tight labor market will encourage businesses to invest more in labor saving equipment and processes. The scarcity of workers also will encourage employers to use their workers much more efficiently, which boosts productivity. We are likely to see less federal government regulation, which will boost productivity growth. Removing regulations that benefit specific groups by protecting them from competition would be especially beneficial to productivity growth and the overall economy. An expected increase in new business formation also should boost productivity growth because new businesses tend to be more productive than older/established firms. In addition, policies that support investment spending in both the public (e.g., infrastructure) and private sectors should boost productivity growth. Finally, the Federal Reserve's step back from its easy money policies will remove a prop that has the unintended consequence of supporting relatively unproductive economic activities. Unfortunately, many of the likely causes of weak productivity growth will not lessen and may intensify. For example, slower gains in educational achievement have probably contributed significantly to sub-par productivity growth. We are simply not adding enough to human capital to generate average, or above average, productivity growth. Since the Great Recession, many state and local governments reduced inflation-adjusted spending per student for both K-12 and higher education. Less public support for the nation's research universities erodes our comparative advantage in innovation. Moreover, pubic spending priorities appear to be moving towards providing more support to the retired rather than to educational institutions and students. Access to higher education therefore will continue to be more expensive. Access for recent generations is more restrictive than it was for the baby boomer generation. Another effect of less public support for higher education is that the U.S. innovation ecosystem will suffer. The aging of the population also limits productivity growth. In general, a less liberal immigration policy limits productivity growth, but not if more visas are given to those with the most skills. Tariffs and trade tensions almost certainly limit productivity growth and can cause productivity to decline substantially. Productivity growth and in turn living standards will rise if the nation's policymakers focus more on improving the innovation ecosystem and focus less on reducing the trade deficit or on restricting the immigration of talented working-age people. Forecast Risks The U.S. economy is operating at the late stage of the current economic cycle. That in and of itself does not imply that a recession is imminent. After all, Australia has avoided a recession for over 25 years. Nonetheless, excesses have developed in both the financial and labor markets, which makes the overall economy more vulnerable to the unexpected shock or major policy blunder than was true earlier in the economic expansion. In addition, federal tax reform is providing a modest late cycle fiscal stimulus, which raises the risk that the Federal Reserve will increase interest rates too aggressively, ending the current economic expansion prematurely. Indeed, the expansion may be particularly vulnerable to even moderately higher interest rates because many years of artificially low interest rates encouraged investors to pile into some very risky assets, including the collateralized loan obligation market – leveraged loans that are securitized.

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