My US leading index, designed to give a year's warning of impending changes in the business cycle, has been rising since May. The (lagged) correlation with the cycle has been excellent, up until the Covid Crash and its consequences. And the gap between what my leading index predicted GDP should have been doing and what it actually did has widened. Why?
My leading index is a combination of monetary measures, momentum measures of the economy, sentiment, and a variety of other leading indicators, all of which have in past led the business cycle. What it doesn't contain is the impact of fiscal stimulus or contraction, and what it can't forecast is what economists call exogenous factors, such as Covid, war, weather, etc.
The gap between what GDP should have done and what it did is due, I think, to two factors. The first is the massive fiscal stimulus of Biden's "Inflation Reduction Act". This didn't just cause plenty of government spending, which directly, and rapidly, expands overall economic activity, it also stimulated private sector spending, especially in the renewables sector. The second is the burst of "revenge spending" as people took advantage of the end of lockdowns to travel, eat out and go to shows.
In the economy, everybody's spending is someone else's income. So stimuli have ripple effects, which only gradually tail off. If a government builds a new freeway, those who work on it have incomes, the cement and steel companies have higher sales, and hire more people, and so on. This higher income leads in turn to more spending, which leads in turn to more income. You get the picture. This means that these ripple effects can amount to much more than the original stimulus, particularly if business confidence is increased.
The ripples of both these stimuli will fade. For fiscal stimulus to keep on expanding the economy, it must be steadily increased, and that won't happen. So growth will slip to more normal levels, but only slowly, as the "ripples" fade. Offsetting that is the improvement in leading indicators, so growth will likely remain reasonable all this year.
In a non-recession year, incumbents tend to win:
First-term incumbency typically provides an advantage — unless there’s a recession during or just before the election. When there is no recession, the incumbent has always won in the post-World War II era. Goldman Sachs Research estimates a 15% probability of a recession over the next 12 months (equal to the average historical probability).
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