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Business Equipment Spending Remains Key Driver in Economic Expansion

Date: May 23, 2019 @ 07:00 AM
Filed Under: Economy

The current U.S. economic expansion, which started in June of 2009, is now the second-longest ever, according to the National Bureau of Economic Research. With strong fundamentals the current expansion will surpass the previous longest, which lasted a full decade through most of the 1990s, in June, and then continue into 2020 and perhaps beyond. However, economic growth will slow over the course of this year and into next as the positive impact of fiscal stimulus wears off and businesses and consumers adjust to more normal levels of interest rates. Business equipment spending, which has been a key driver of the current expansion, will continue to increase, but growth will slow along with that of the overall economy over the next couple of years.

Economic growth has picked up in the United States since a slowdown in 2016 and 2017. Real GDP growth was 2.9 percent in 2018, the best year since 2015, and well above the average since the end of the Great Recession of 2.2 percent. A number of factors supported growth last year: an expanding global economy, a decline in the dollar that made exports from the U.S. less expensive and imports into the U.S. more expensive, and an increase in domestic energy production as energy prices stabilized after a drop from 2014 to 2016.

Fiscal stimulus also boosted U.S. economic growth in 2018. Congress passed a big cut to corporate income taxes at the end of 2017 that took effect at the beginning of last year. This boosted after-tax corporate profitability and also provided incentives for business investment. Although corporations used much of the tax cut to boost their share prices through increased dividends and stock buybacks, the tax cut did boost spending on equipment. The law also included a smaller personal income tax cut that boosted take-home pay for workers, allowing them to increase their spending.

Fiscal stimulus in the form of increased government spending is also supporting the economy.  In the spring of 2018 Congress voted to increase the spending caps on discretionary spending, that which must be approved by Congress every year, for fiscal years 2018 and 2019. As a result the federal government has boosted its purchases of goods and services, adding to demand in the U.S. economy. This stimulus from greater federal spending will last into next year.

Consumer spending, which accounts for two-thirds of the U.S. economy, remains the key driver of the current expansion. The fundamentals for consumers remain very good in the spring of 2019. Job growth has averaged better than 200,000 per month over the past year, more than double the pace needed to keep up with underlying growth in the workforce. The unemployment rate has fallen from a peak of 10 percent in late 2010 to 3.6 percent in April, a five-decade low. The tight labor market is also boosting wages. As of April average hourly earnings were up 3.2 percent from one year ago, up from wage growth of less than 2 percent in late 2012, when the job market was just beginning to recover from the Great Recession. Low inflation and the recent personal income tax cuts are also positives for consumer spending this year.

With the U.S. and global economies both expanding, businesses are investing to boost output. U.S. real capital expenditures—investment in equipment and nonresidential structures, adjusting for inflation—rose 6.3 percent in 2018, well above the pace of overall U.S. economic growth, after a big increase of 4.5 percent in 2017. Rising corporate profits, the corporate income tax cut, low borrowing costs and easy access to credit are all positives for spending on equipment. The tight labor market is another driver; as it becomes more expensive to hire, firms are undertaking investments to make their existing workforces more productive, such as new technologies and equipment. And falling commercial vacancy rates and rising rents are boosting commercial construction and associated equipment sales, although construction of traditional retail space continues to suffer from the movement toward online sales.

U.S. economic growth is expected to slow over the course of 2019 and into 2020, however. Fiscal policy will remain a positive for growth this year, but is likely to be neutral for growth in 2020 as the impact of tax cuts and spending increases fades, and then turn into a drag in 2021 as larger federal government budget deficits lead to spending cuts. Job growth will slow as the tight labor market constrains hiring; this in turn will weigh on growth in household incomes and spending. Global economic growth has slowed and the dollar strengthened in late 2018 and early 2019, which will weigh on U.S. exports. And although interest rates remain low on an historical level, they are up from a few years ago as the Federal Reserve has normalized monetary policy in response to the improving labor market. PNC is forecasting U.S. real GDP growth of 2.3 percent this year and 2.0 percent next year. The expansion will continue, at least into 2020, but growth will be noticeably weaker than it has been in recent years.

This slower growth will weigh on business capital spending, with growth expected to slow to 4.0 percent this year and 2.7 percent in 2020, although this is still above the pace of overall economic growth. One positive will be residential construction-related equipment, as the homebuilding industry will benefit in the near term from strong demand for single-family housing and a recent drop in mortgage rates.

The risk of recession remains low, at least in the near term. PNC estimates that the probability of recession this year is only 15 percent, but that will rise to 30 percent in 2020 and 50 percent in 2021 as slowing growth will make the expansion more vulnerable to an external shock or a policy mistake.

Risks to the outlook, both for the overall economy and equipment spending, are weighted to the downside. An extended trade war between the U.S. and its major trading partners could push the global economy into recession and create significant drag for the U.S. economy. An abrupt exit of the United Kingdom from the European Union is also a significant downside risk. Business debt levels have increased dramatically over the past few years, leaving firms vulnerable to a slowdown in profitability or a tightening in credit. However, there are a few upside risks to the U.S. outlook. Labor force growth could be stronger than expected, allowing businesses to increase output more easily. Technological innovations could lift productivity growth. With the Federal Reserve now expecting to keep its policy rate unchanged in 2019, the risk from a monetary policy misstep has diminished. And a big positive for capital spending would be a major infrastructure bill that would boost federal investment, creating demand for all sorts of business equipment.

Augustine (Gus) Faucher
Senior Vice President and Chief Economist | The PNC Financial Services Group
Augustine (Gus) Faucher is Senior Vice President and Chief Economist of The PNC Financial Services Group, serving as the principal spokesperson on all economic issues for PNC.

Prior to joining PNC as senior macroeconomist in December 2011, Faucher worked for 10 years at Moody’s Analytics (formerly, where he was a Director and Senior Economist. He was responsible for running the firm’s computer model of the U.S. economy, edited a monthly publication on the U.S. economic outlook, covered fiscal and monetary policy, and analyzed various regional economies. Previously, he worked for six years at the U.S. Treasury Department, and taught at the University of Illinois at Urbana-Champaign. He was named Senior Vice President in March 2015, Deputy Chief Economist in February 2016, and to his current role in April 2017.

Faucher is frequently cited in international, national, and regional media outlets including The Wall Street Journal and The New York Times. He has appeared on ABC World News, CBS Evening News, NBC Nightly News and Nightly Business Report, and is regularly featured on CNBC, CNN and Fox Business. In addition, he appears regularly on CBS Radio, NPR and Marketplace.

Faucher earned a Ph.D. in economics from the University of Pennsylvania, with concentrations in labor economics and public economics. He also has a B. A. in economics from Cornell.
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