FORT WORTH, Texas–For the economy to grow continued immigration is going to be critical, according to one Fed president, who also shared with credit unions views on other threats to economy and his own forecast for what lies ahead.
In remarks to the Cornerstone CU League’s annual meeting here, Robert S. Kaplan, president and CEO of the Federal Reserve Bank of Dallas, responded to questions related to the U.S. economy, “secular issues” that need to be addressed, and how much longer the U.S. federal government can continue to take on growing debt.
The Q&A, which was moderated by Kent Lugrand, president and CEO of InTouch Credit Union, is below.
Q: What is your assessment of the U.S. economy?
Kaplan: For 2017, our Dallas Fed forecast is GDP will grow in excess of 2%. The reason we are optimistic is that the household sector in the U.S. is in relatively good shape. We have spent the last eight years since the financial crisis with the household sector deleveraging. Income has now caught up. The consumer sector is 70% of economy; that doesn’t mean they will spend, but we believe they will. Based on that 2% growth, it is our view you will see more slack taken out of the labor market, and the unemployment rate that is now at 4.7%, we think, can actually go lower and that inflation can move toward the 2% Fed objective.
Q: What do you see as biggest threat to economy?
Kaplan: Here is the challenge to the U.S. First and foremost, it’s an aging population. The demographics of this country are such that the workforce is aging and participation rates are declining. In 2007, the participation rate was 66% and today it’s 63%, and the bulk of that decline is demographic. In the next 10 years, we think that statistic will be closer to 61%. This is a big problem, because what makes up GDP? It’s growth in labor force and growth in income. A lot of people say, meh, 4.5% unemployment isn’t a real number, you should look at ‘discouraged workers.’ I like to look at ‘U6’ data, which is the unemployed, discouraged workers, and people working part-time who would like to go full-time. The challenge is that number, on the bright side, is at 8.9%. The problem is the pre-recession low in that number was 8.1%. So, in a 160-million-person workforce, that’s about a million and a half people we can move into the workforce, but it tells me we’re not at full employment, we’re moving closer. If we don’t have more labor force growth, we’re going to have slower GDP growth. At some point in this country we’re going to have to come to grips with immigration. Immigrants have made up more than half the workforce growth in this country over the last 20 years.
Q: You discuss secular issues. Why are they important?
Kaplan: I’m a business person, I’m not a Ph.D. economist. We have 30 Ph.D. economists at the Dallas Fed for whom I have great respect. Economists look at data and talk about things you can measure. I look at data, too, but in your business and mine I look at drivers. My experience is that profits come as result of doing the right fundamental thing for a number of years.
Technology interruption is effecting every person in this room and every industry, and it’s increasingly replacing workers. The reason I talk about it a lot is it is being confused. People lose jobs and think it’s immigration and trade; increasingly, it’s neither. It’s Amazon, it’s other disruptors creating new business models enabled by technology. It’s causing more and more people to lose their jobs and need to be retrained. We’ve been too slow in the U.S. in need to retrain those people.
Second, businesses don’t have as much pricing power. It’s hard to raise prices because a consumer can use technology very easily to buy elsewhere. So, businesses are trying harder than ever to replace workers with technology, because they don’t have a lot of pricing power. These prescriptions matter, because they affect the diagnosis.
Globalization has been a major force. We are quite competitive now with the rest of the world due to our integrated supply chains with Mexico. If we didn’t have that relationship we would likely lose these jobs to Asia. So, if you think the reason for job loss in America is immigration and trade, you might deteriorate the relationship with Mexico, and make it worse. It’s not enough to create a job here; you have to be competitive with the rest of the world.
Q: What is driving Fed rate increases and what about future rate increases?
Kaplan: The Fed has dual mandate, as you know: full employment and price stability, or a 2% inflation objective. We are moving slowly toward our 2% inflation objective and as we do we remove accommodation, which is we raise the Fed Funds rate, I think it’s critical we do it gradually and patiently and understand these secular headwinds. I know in your business you don’t just look at the Fed Funds rate, you look at the 3-year, 5-year, 10-year and the curve. When the 10-year moves (down) it is telling you something about its expectations of future growth, and in this case, it may be more tepid than many think. I think growth over next 10 years by historical norms will be relatively sluggish.
Q: You often discuss fiscal policy and structural reforms; why are these key issues?
Kaplan: The one thing those big secular forces have in common is that monetary policy isn’t going to have a big effect on those. Raising rates, allowing balance sheet to run off, are critical functions, but historically it’s been alongside fiscal policy and structural reforms. I want to remind people that we have been lulled over eight years of just having monetary policy and believing it can solve all these issues. My job is to say, “No, it can’t.” What is structural reform? Skills training, healthcare reform. Infrastructure spending is part fiscal, part structural. We need to look at those actions that improve U.S. competitiveness. We can’t do many of those reforms at the Fed. Other policymakers at the federal and the state and local levels need to do this.
Q: In Texas with energy, how is Texas economy doing and how much more diverse is the Texas economy today than it was in the 1980s?
Kaplan: Texas is bucking many trends. The big headline since the 1980s has been the energy bust, but the state is dramatically more diverse today than it was in the 1980s. In 2014, the energy sector was 14% of the state GDP; today it’s closer to 7% or 8%. Part of that is decline in the energy sector, but part of it is the growth in population and companies coming to Texas. Today, the Texas population is pushing 28 million. People are migrating here, and we have a very diversified, very healthy state. Energy has been a headwind the last two years; our view is the global supply and demand of energy is getting in balance. Demand keeps growing and it’s moving toward becoming a bit of a tailwind.
Q: Since being at the Dallas Fed, why have you been so focused on education?
Kaplan: I have a background in it. But number two, GDP comes from increase in workforce and growth in productivity. Every study shows a high correlation between education and health and whether you are incarcerated. All the outcomes get better with education. The problem is we’re focusing on school systems, but we’re finding that if a child starts out behind they never catch up. So, I’m a big believer in backing programs to improve early childhood education, because if we do we will have better educational attainment and more productivity and higher GDP and higher prosperity in the state.
Q: How long can the federal government continue to go into debt, and with all the commitment to social programs, can we ever balance the budget?
Kaplan: Debt held by the public is about 77% of GDP. So, how much is too much? Historians and economists have said we’re starting to approach a level that’s not sustainable. What helps the United States is we are the world’s reserve currency when the world is looking for safety. But my own view is we either have to grow faster and, along with it, find ways to slow the growth of these debt levels, and we may have to do things with entitlements like Social Security, which is very easy for me to say. We are going to have to bend the curve. The war of 2008 was how to deleverage and de-risk. The war of 2017 is we have to grow.
Q: Do you agree over-regulation is hurting smaller institutions?
Kaplan: Yes, I do. When we talk about regulation I believe we should have to segment small banks and institutions and large banks. I don’t think the country will be harmed by very tough regulation and stress-testing for big banks. It doesn’t hurt the economy. But it is hurting the economy for small and mid-size banks, and they are merging out. They don’t pose systemic risk. I know it horrifies bank examiners to say we might have a few more failures, but it won’t hurt the country. We have to have more tailored regulation for small and midsize banks.