Where Is The U.S. Economy Heading In 2016?

 | Feb 07, 2016 06:08AM ET

The US economy experienced strong growth in the second and third quarters of 2015, expanding by 3.9% and 2.0% respectively. However, the strong performance was derailed in the fourth quarter, which saw the economy growing by only 0.7%. The slowdown was largely due to divestments in the energy sector and a negative contribution from net exports. The drag from these two factors is expected to continue in 2016, but we project that strong consumption will lift US growth to around 2%, slightly above potential.

We can analyse activity in the US economy by examining its different components:personal consumption, private-sector investments, government expenditure and net exports. The sum of these components yields a measure of aggregate demand in the economy that is termed gross domestic product, or GDP.

So how do we see each of these components faring in 2016?

We expect private consumption to continue to grow in 2016 at around 3.3%. This is by far the largest component of GDP, accounting for nearly 70%. The US consumer is enjoying an array of favourable conditions. Wage growth has picked up in recent months to reach 2.5% in December. Employment has increased by an average of over 220k per month in 2015, and unemployment has fallen to 5.0%. The strong recovery in the labour market and the decline in the unemployment rate implies that higher wages are benefiting more people. Consumers’ spending power has been further strengthened by the decline in oil prices, which has freed up some of their income. One might argue that the recent decline in equity prices (7.5% so far this year) might reduce consumers’ wealth, which could reduce their spending. However, any such effect is likely to be small and offset by rising house prices. Indeed, surveys show consumer confidence is high and rising, undented by the recent decline in equity prices.

The picture is not so rosy for investments. Lower oil prices are pushing US energy firms to cut their capital spending. In addition, inventories have been rising at a fast and unsustainable pace, which is likely to be a drag on growth in 2016. On the other hand, we expect other components of investments to grow at a moderate pace, especially residential investments, boosted by a recovering housing market. Overall, we expect investment growth to slow from 4.8% in 2015 to 1.6% in 2016, the slowest growth rate since 2009.

We project government spending to have only a minor effect on growth. Fiscal policy in the US is currently neither expansionary nor contractionary and therefore unlikely to impact growth significantly.

Contributions to annual real GDP growth

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