A few bumps for the economy

OPINION:

Stocks on a roller coaster and surging inflation have just given policymakers and ordinary folks a jolt. Caution is always prudent but this is hardly time to panic.

Over the last three quarters, economic growth averaged nearly 3 percent, corporate profits surged and similar performance is expected for 2018.

That hardly would have been remarkable during the Reagan and Clinton years — growth averaged 3.4 percent. For too long, policy wonks and politicians, save the current White House, have been overly pessimistic about what Americans can accomplish.

Unemployment stands at about 4.1 percent — well below the sustainable level of 4.6 percent, as computed by economists who worry about such things. According to the Philips Curve, a doctrine adhered to by most practitioners of the dismal science, wages and prices should be flying out of control, and the Federal Reserve aggressively raising interest rates.

Wages are rising about 2.9 percent a year but factoring in productivity growth, that translates into long-term inflation of less than the Fed’s target of 2 percent.

Unemployment is depressed these days because millions of prime working aged adults have opted out of the labor force. President Obama expanded access to Medicaid and food stamps and enabled lax enforcement of standards for Social Security disability pensions.

Wages moving up a bit more briskly should make sloth relatively less attractive to work and coax more adults to seek gainful employment.

The recent tax cuts and defense and domestic spending increases are a two-edged sword. Those will boost business investment and demand for what Americans make, but also bring inexorable budget pressures on Congress to start curbing entitlement eligibility so that only the truly needy are helped.

And deficits exceeding $1 trillion will limit policymakers’ capacity to add stimulus when the economy next hits a speed bump — a recession that could be severely deepened if Washington is instead forced to cut spending by international lenders.

Near-term, however, robotics and artificial intelligence are about to free up a lot of workers for other jobs, dramatically boost productivity growth and enable faster wage growth.

A further run-up in stock and property prices could worry Fed policymakers that a bubble may burst. However, stocks are hardly overvalued — the S&P price-to-earnings ratio is currently below its 25-year average—and rising corporate earnings are likely to sustain more gains in 2018.

Cheap land was a great luxury for the post-World War II generation but in recent decades, the availability of developable land near jobs in large metropolitan areas has become increasingly scarce. Cities have tightened zoning rules, making denser housing developments more difficult. Those combine to keep pushing up land values, rents and sustainable housing prices.

The same goes for building materials — North America has only so much harvestable lumber — and with a rising population something has to give. You guessed it, housing prices.

It really doesn’t matter what the Fed does, as long as it does not act precipitously, dramatically drive up mortgage rates and put the skids on the housing market. Land values and housing prices are going to rise because those are needed to encourage building adequate to the pace of new household formation.

During the recent recovery, factors other than unemployment have held down inflation—expanded competition from imports, increased price competition enabled by internet commerce and commodity prices depressed by excess capacity from the overhang of the Great Recession and the revolution in U.S. oil production.

Those have mostly run their course, and we are going to have more inflation no matter what the Fed does about interest rates, unless Fed Chairman Jerome Powell is bent on radical actions that would thrust the global economy into the great abyss again.

I doubt he is much interested in that and consequently, we can look forward to a period of moderate inflation, the Fed gradually raising interest rates and the stock market accommodating both.

The Fed is targeting three small interest rate increases each year until the overnight bank lending rate reaches about 3 percent. That should put the 10-year Treasury and 30-year fixed mortgage rates at 3.4 and 4.8 percent by early 2020.

The economy and stock market have sustained robust performance at much higher rates and near-term, we have few reasons to fret that things are any different.

• Peter Morici is an economist and business professor at the University of Maryland, and a national columnist.