The 2018-19 May Revision: LAO Economic Outlook

The 2018-19 May Revision: LAO Economic Outlook Translate Our Website This Google ™ translation feature provided on the Legislative Analyst's Office (LAO) website is for informational purposes only. The LAO is unable to guarantee the accuracy of this translation and is therefore not liable for any inaccurate information resulting from the translation application tool. Choose your language: × Skip to main content Home --> Policy Areas Capital Outlay, Infrastructure Criminal Justice Economy and Taxes Education Environment and Natural Resources Health and Human Services Local Government State Budget Condition Transportation Other Government Areas Publications The Budget Propositions and Initiatives Staff Careers About Us Search LAO Contact Carolyn Chu See More Publications Like This Back to the Top --> Tweet May 12, 2018 The 2018-19 May Revision LAO Economic Outlook Our office just released a summary of our updated state fiscal outlook for the May Revision . Our fiscal outlook is premised on a set of economic assumptions. While our November fiscal outlook included multiple economic scenarios, our update for May Revision focuses on only one economic scenario: continuation of moderate economic growth. Our May Revision economic scenario is based on the average of a collection of publicly available forecasts from various institutions and professional economists as compiled by Moody s Analytics. Figure 1 below highlights the major economic variables in our economic scenario, as well as the administration s economic forecasts in both January and May. Both our outlook and the Department of Finance s new economic forecast assume moderate growth over the next year or so. One key difference between our office and the administration is that our economic scenario assumes notably higher wage and salary growth in 2018 and 2019. Figure 1 Comparing Recent California Economic Scenarios Percent Change Unless Indicated 2018 2019 Administration Jan 2018 Administration May 2018 LAO May 2018 a Administration Jan 2018 Administration May 2018 LAO May 2018 a United States Real gross domestic product 2.5% 2.7% 2.8% 2.2% 2.9% 2.4% Personal income 3.9 4.5 4.6 4.8 5.4 4.3 Wages and salaries 4.4 4.9 5.4 5.0 5.2 4.9 Employment b 1.3 1.7 1.4 1.0 1.7 0.7 Unemployment rate (percent) 4.0 3.9 3.9 4.0 3.6 3.8 Consumer price index 2.1 2.3 2.8 2.2 2.1 2.3 Target federal funds rate (percent) 1.6 1.8 2.0 2.3 2.8 2.8 S&P 500 (annual average) 2,612 2,670 2,715 2,622 2,670 2,494 California Personal income 5.2% 5.6% 5.4% 3.9% 4.8% 5.5% Wages and salaries 5.9 6.0 6.8 3.7 4.1 6.7 Employment b 1.5 1.7 1.4 1.3 1.4 1.4 Unemployment rate (percent) 4.9 4.6 4.3 4.9 4.4 4.2 California consumer price index 3.0 3.1 3.3 2.9 2.8 2.8 Housing permits (thousands) 122 130 117 139 145 120 Single unit 60 65 57 66 72 60 Multi unit 62 65 60 73 73 61 a An economic growth scenario based on Moody’s Analytics’ April 2018 U.S. “consensus scenario.” The LAO develops the California portions of the forecast based on this scenario. b Employer survey data. Figure 2, at the end of this post, lists the major economic variables under our new moderate growth scenario through 2022. As we discussed in November, accurately predicting the future path of the economy is not possible. The consensus scenario we use is only one possible path for the U.S. and California economies. Key Issues for the Future Trajectory of the State s Economy. Our economic scenario reflects the consensus belief of professional economists that the current economic expansion is likely to continue through the end of the decade. A multitude of factors, however, will influence the path of the state s economy in ways that are very difficult to anticipate. Some of these factors are discussed below. Tight Labor Markets. The state s unemployment rate (4.2 percent as of March 2018) is the lowest it has been in decades. When unemployment is low and falling, economists generally expect wages and prices to rise. With a limited number of people looking for jobs, competition among employers for workers is high. This competition typically forces employers to pay higher wages to attract new workers. Rising wage costs, in turn, cause businesses to raise their prices. Recent wage and price growth has not been as high as many economists had expected given low unemployment. Nonetheless, wage and price growth is expected to pick up soon, although it is difficult to say exactly when this will happen or by how much. Federal Reserve Actions. With growing upward pressures on prices, the Federal Reserve is likely to take actions in the coming months to temper economic activity by increasing interest rates. Higher interest rates make it more expensive for businesses to expand their operations or consumers to finance purchases. As such, these interest rate increases would slow economic growth in the U.S. and California. The precise timing and impact of Federal Reserve actions is unclear. Trade. Several recent developments have cast uncertainty over the terms of trade between the U.S. and other countries. The federal administration currently is renegotiating the North American Free Trade Agreement, an agreement that eliminates many barriers to the exchange of goods among the U.S., Canada, and Mexico. These negotiations are ongoing. In addition, in recent months, the U. S. and China have engaged in a series of back-and-forth threats to impose tariffs (taxes on imported goods) on goods commonly traded between the U.S. and China. To date, the tariffs that actually have been implemented cover a small slice of economic activity in the U.S., but the threatened prospective tariffs on both sides are much broader. Major changes to North American Free Trade Agreement (NAFTA) or escalation of the U.S.-China disputes could have significant impacts on businesses that sell many of their goods to Canada, Mexico, and China, as well as on the prices paid by consumers and businesses for goods and services imported from these countries. Asset Prices. Some signs suggest that two important assets stocks and homes in certain markets are somewhat overvalued. The price of stocks is related, over the long term, to corporate earnings. Accordingly, price-to-earnings (PE) ratios are one key metric used to evaluate stock prices. As of early May, the PE ratio of the Standard and Poor s 500 index was 24.5. The typical PE ratio since 1990 is 21 (19 if the dot-com bubble of the late 1990s and early 2000s is excluded). Similar to the price-to-earnings ratio, the home price-to-rent ratio is used to gauge if home prices are in line with underlying demand for housing. While price-to-rent ratios for the state as a whole appear to be in line with historic norms, certain housing markets in the San Francisco Bay Area appear to be a little overheated . While these markets represent a minority of homes in the state, the Bay Area contributes disproportionately to the state s economic activity and tax revenue. Figure 2 LAO May 2018 Economic Growth Scenario a Percent Change Unless Otherwise Indicated 2017 2018 2019 2020 2021 2022 United States Real gross domestic product 2.3% 2.8% 2.4% 2.0% 1.8% 1.7% Personal income 3.1 4.6 4.3 3.6 3.0 3.4 Wages and salaries 3.3 5.4 4.9 3.4 2.0 2.7 Employment b 1.6 1.4 0.7 0.6 0.4 0.8 Unemployment rate (percent) 4.4 3.9 3.8 3.9 4.0 4.3 Consumer price index 2.1 2.8 2.3 2.1 2.1 2.0 Target federal funds rate (percent) 1.00 1.96 2.75 2.93 2.97 2.98 S&P 500 (annual average) 2,448 2,715 2,494 2,567 2,786 2,998 California Personal income 4.1% 5.4% 5.5% 4.6% 4.0% 4.2% Wages and salaries 4.7 6.8 6.7 5.2 3.8 4.1 Employment b 1.8 1.4 1.4 1.3 1.2 1.5 Unemployment rate (percent) 4.8 4.3 4.2 4.2 4.1 4.0 California consumer price index 3.0 3.3 2.8 2.6 2.6 2.5 Housing permits (thousands) 113 117 120 122 122 124 Single unit 56 57 60 61 60 60 Multi unit 57 60 61 61 62 64 a Based on Moody’s Analytics’ April 2018 U.S. macroeconomic “consensus scenario.” The LAO develops the California portion of the forecast based on this scenario. This is not a prediction for the future track of the economy, but rather only one possible economic scenario. Uncertainty about the future economy increases with each additional year. b Employer survey data. Subscribe | California State Legislature | Online Voter Registration | Privacy Policy | Accessibility Legislative Analyst's Office | The California Legislature's Nonpartisan Fiscal and Policy Advisor 925 L Street, Suite 1000 Sacramento, CA 95814 | (916) 445-4656