US economy may be poised for a supply-side surprise

Washington

WILL 2018 be the year the supply side of the economy roars back to life? If so, the Federal Reserve's expectations for inflation may once again be met with disappointment. But be wary of believing this would portend a dovish year for policy. A supply-side rebound would likely trigger upward pressure on the long end of the yield curve, giving the Fed more room to raise rates.

The central bank has a pessimistic view of the economy's fundamental capacity for growth. According to the Summary of Economic Projections, policy makers hold a median estimate of longer-run growth of just 1.8 per cent. Low labour force growth and productivity account for this anaemic number.

Policy makers anticipate growth of 2.5 per cent this year, well in excess of the growth of the supply-side economy. Given that the Fed believes labour markets are already stretched to, and possibly beyond, full employment, such growth would eventually fuel inflationary pressures. To stave off that outcome, central bankers expect they need to raise interest rates 75 basis points this year. The Fed expects this pace of tightening (forecast to continue into 2019) should be sufficient to ease growth back to a more sustainable leve…