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15 9 higher tariffs fully, which implies reduced profit margins. It is also important to recognize that financial institutions' profit margins will be severely constrained by a much flatter than normal yield curve. On the plus side, low interest rates will assist growth in corporate profits, especially for debt-heavy and capital- intensive businesses. Businesses are likely to see some regulatory relief, which could lower production costs and increase productivity. Expense management and more broadly based – albeit moderate – growth in demand for goods and services will help to support profits. Cash flow will be weaker, but financing should still be easy to obtain, and as noted above it will be inexpensive. The recovery of housing markets and substantially more single-family homebuilding will boost profits for many home-related industries. Growth in spending for business equipment bodes well for profits earned by technology-oriented companies. Productivity growth is likely to be positive in 2020, but very weak from a historical perspective. That is unfortunate because productivity is a panacea for profits, wages, and the overall economy. International Trade Uncertainty about U.S. trade policy and tariffs adds considerable risk to the 2020 forecast. The Phase One trade deal suggests that trade tensions will not escalate in 2020. Indeed, the Terry College's baseline forecast assumes that the U.S.-China trade war does not escalate, but it also assumes that trade tensions will remain very high. Under that assumption, in 2020, real exports and imports will grow, but imports will rise faster than exports. The 2020 trade gap will be larger than in 2019. Hence, net exports will be a negative factor in terms of U.S. GDP growth. The main obstacles to faster U.S. export growth are the same as in 2018-19: the trade war and the strong U.S. dollar. In addition, foreign GDP growth will be slower in 2020 than in 2019. The main reason why imports will grow in 2020 will be the growth of households' disposable personal income. Higher incomes prompt U.S. consumers to purchase more imported finished products and go on more trips abroad, but households' wealth-effect spending will be absent in 2020. In 2020, U.S. export growth will be broad based. There will be increases for both merchandise and services. Additional tariffs and trade tensions increases the chances that export growth will reverse, potentially pushing the U.S. economy into recession. In 2020, the U.S. dollar's value will be quite high, which limits prospects for U.S. exports. The U.S. dollar probably will depreciate slightly in 2020, but the depreciation will be minor compared to the appreciation that has recently transpired. Inflation & Monetary Policy Despite the inflationary push from tariffs, consumer price inflation will increase by only 1.7 percent in 2020, which is the same rate expected for 2019. That rate of inflation is below 2.0 percent level that the Federal Reserve appears to be targeting. The main reason why inflation will be low is that the economy is weak. The Federal Reserve is very likely to reduce policy interest rates. In 2020, one 25-basis-point decrease in the federal funds rate target will bring cumulative easing over the course of 2019- 20 to 100 basis points. Tariffs are inflationary, but many of the usual drivers of inflation will be less intense in 2020. For example, the pace of 2020 GDP growth will be about half the pace expected for 2019, which reduces the prospects for inflation. Similarly, consumer spending will grow more slowly in 2020 than in 2019. Capacity utilization will be lower in 2020 than in 2019, with considerable excess capacity in some economic sectors. The strong dollar will help keep inflation at bay, but the dollar will depreciate slightly in 2020. In 2020, labor market conditions will not be strong enough to ignite rapidly accelerating inflation. Indeed, employment will grow much more slowly in 2020 than in 2019. The bottom line is that the employment situation will not reach the point where labor market conditions will support higher inflation, but not rapidly accelerating inflation. Thus, the Federal Reserve can loosen monetary policy without worrying too much about inflation getting much traction in 2020. Based on the 2020 forecast of much slower U.S. GDP growth, the Federal Reserve will continue to reduce short-term policy interest rates in 2020. The federal funds rate target will fall to 1.5 percent by the end of 2020. At that point, short- term policy interest rates will be very stimulative. Nonetheless, those rate decreases will not prevent inflation from falling short of the Federal Reserve's two percent target, but it will not fall short by very much – 0.3 percentage points if the forecast is correct.

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