Savannah Chamber

13 6 unwinding quantitative easing—and probably will allow a proportion of maturing assets to roll off. It will not sell Treasuries or mortgage backed securities. Crude Oil Markets 7 If there are no additional significant supply interruptions or additional price premiums due to increased political tensions, it is unlikely that oil prices will go much higher than $55 per barrel. That is slightly above the approximate breakeven price for U.S. shale oil production. Prices higher than $50 will make U.S. shale oil and other marginal producers ramp up production. 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 means that oil will trade significantly higher. Right now, there is no shortage of potential negative supply shocks, ranging from the Nigeria Delta Defenders, to the economic crisis in Venezuela, to ISIS, to Libya's ability to sustain production, to hurricanes in the Gulf of Mexico. This forecast assumes a slight acceleration in the modest 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 GDP growth is below-average productivity growth. In 2018, the pace of productivity growth will increase only slightly, however. Since the recession ended, there has not been very much capital deepening. That may change. In 2018, 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 significantly less federal government regulation, which will boost productivity growth. An expected increase in new business formation also should boost productivity growth because new businesses tend to be more productive. In addition, policies that support investment spending in both the public and private sectors should boost 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 may intensify. For example, slower gains in educational achievement have probably contributed significantly to the recent run of sub-par productivity growth. We are simply not adding enough to human capital to generate average, or above average, productivity growth. Moreover, pubic spending priorities do not appear to be moving towards providing more support to the retired rather than to students. Access to higher education will continue to be more expensive. In addition, a less liberal immigration policy might limit productivity growth, but not if more visas are given to those with the most skills. Forecast Risks The U.S. economy is operating at the late stage of the current economic cycle, which in itself does not imply that a recession is imminent. But, with the year-over-year rate of GDP growth predicted at a below-average rate, the economy will be vulnerable to economic shocks and/or policy mistakes. In addition, excesses are beginning to appear in both the financial and labor markets, which makes the overall economy more vulnerable than usual. The main risks to economic growth are (1) financial panics and/or massive shifts in asset prices, (2) mistakes in U.S. fiscal or monetary policies, (3) geopolitical tensions, (4) a hard landing in China, and (5) a full-blown trade war. Risks to the outlook have increased. The probability of recession beginning sometime in 2018 is 40 percent, which is higher than the 35 percent probability estimated at this time last year. The higher risk of recession mainly reflects concerns about inflated asset prices (e.g., equities and bonds). At the time of this writing, all the popular price/earnings ratios were well above their long-term averages. Consumer spending is sensitive to equity prices. As always, energy prices are a wild card. Finally, informal executive branch communications and/or policy changes with the potential to destabilize markets are impossible to handicap with any degree of confidence, but add somewhat to the overall riskiness of the economic environment.

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