Economic Developments – January 2018 

© 2018 Fannie Mae. Trademarks of Fannie Mae. 1.10.2018 1 of 5 

Fiscal Policy and the Fed: Stimulus/Response 

Late last year, the President signed the Tax Cuts and Jobs Act into law. Most economists upgraded their economic growth 

forecasts when they incorporated the impact of a likely or final tax cut bill. For example, more than 90 percent of 

economists who participated in the Wall Street Journal monthly survey said in January that the tax cuts would increase 

economic growth over the next two years, similar to their thinking in earlier months when details of the legislation began 

circulating. Between October and January, the average forecast for 2018 real gross domestic product (GDP) growth is 0.3 

percentage points higher, from 2.4 percent to 2.7 percent. Results from the January Blue Chip survey also showed the 

same expected growth bump during the same period. The rationale for the improved outlook is that cuts in individual tax 

rates should help spur consumer spending, while reductions in corporate tax rates and the allowance for equipment 

investment to be fully expensed for five years are expected to boost business equipment spending. 

The biggest threat to continued economic expansion cited by Blue Chip respondents is a faster-than-expected rise in 

interest rates stemming from either higher inflation or a policy mistake by the Federal Reserve. This concern is based on a 

belief in a tradeoff between employment and inflation—the so-called Phillips Curve. In our view, this tradeoff has little 

empirical support in recent decades, and thus aggressive monetary tightening intended to preempt inflationary pressure 

may do more harm than good. History tells us that managing a “soft landing” has been a quite difficult task for policy 

makers, and the Fed’s reaction to the Tax Act is key to the expansion that is expected to reach its ninth anniversary this 

June. Thus, our theme for 2018 is “Fiscal Policy and the Fed: Stimulus/Response.”

The extent to which stimulative fiscal policy will accelerate growth, 

and the resulting impacts on the unemployment rate and inflation, 

are subjects of considerable debate among economists. Although 

the expansion appears to be late in the business cycle, with the 

unemployment rate near historical lows, we believe that the labor 

market contains more slack than suggested by the unemployment 

rate. The tax bill should create demand for labor, leading to tighter 

labor market conditions and accelerating wage growth, which 

should draw more prime-age (25- to 54-year-old) workers into the 

labor force. The prime-age labor force participation rate has been 

trending up over the past year but remains well below the prerecession level, suggesting an untapped reservoir of labor not 

reflected in the very low unemployment rate. 

We also expect the tax bill to lead to stronger growth in business 

equipment investment, which is key to stronger productivity 

growth. Productivity growth has been anemic on average in the 

current expansion. However, amid robust growth in equipment 

investment last year, productivity growth has started to rise from 

a very depressed rate. Stronger productivity growth, even in the 

midst of rising compensation, should keep labor costs, core 

inflation, and inflation expectations contained. Therefore, we 

believe gradual monetary policy normalization can be consistent 

with stronger economic growth and a longer expansion. 

We revised higher our economic growth forecast for 2018 by 0.6 

percentage points to 2.7 percent and for 2019 by 0.5 points to 

2.3 percent. The improved outlook stems largely from stronger 

anticipated consumer spending and business equipment

investment, which are expected to be partially offset by faster 

import growth. The unemployment rate is projected to average 3.7 percent in the second half of 2019, three-tenths lower 

than in the prior forecast and the lowest level in fifty years. However, we expect inflation to remain subdued, due to an 

anticipated increase in labor supply and a continued pickup in productivity growth from increased capital expenditures that 

70%

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'70 '75 '80 '85 '90 '95 '00 '05 '10 '15 Hundreds Labor Force Participation Rate (SA, %)

Prime-Age Labor Force Participation Rate Has More Room to Run

16 Years and Older

25-54 Year Olds (Right Axis)

-2.0%

0.0%

2.0%

4.0%

6.0%

'85 '90 '95 '00 '05 '10 '15 Total Nonfarm Productivity (Y-o-Y % Change)

Productivity Shows Signs of Life
© 2018 Fannie Mae. Trademarks of Fannie Mae. 1.10.2018 2 of 5

should help offset rising worker compensation. We project the annual increase in the Fed’s favored measure of inflation, 

the Personal Consumption Expenditures Deflator, to remain below the Fed’s two-percent target throughout 2018.

 

The corporate tax cut should be a boon for business equipment investment. During the third quarter, business investment 

in equipment posted the strongest quarterly increase in three years. Incoming data suggest it ended 2017 on a strong 

note, setting the stage for continued acceleration this year amid very high business confidence. While small business 

confidence edged down in December, the average reading for all of 2017 set a record high since the monthly survey from 

the National Federation of Independent Business (NFIB) began in 1986. The tax bill should encourage businesses to 

accelerate capital expenditures, especially given that the 100-percent expensing will expire in five years and will be 

phased out over the subsequent five years. However, the lowering of the corporate income tax rate to 21 percent from 35 

percent also makes the deduction less valuable, countering some of the benefits. We expect little investment impact from 

the one-time repatriation tax on accrued foreign profits, as past experience suggests that repatriated cash will likely be 

used for dividends and share buybacks.

On the individual taxpayer front, because the tax bill also changed

deductions (e.g., doubled the standard deduction and placed a

$10,000 cap on combined state and local tax (SALT) and property 

tax deductions), its impact on final tax payments could vary 

significantly among households across the nation. Meanwhile, 

taxpayers can choose to spend the increased disposable income,

save it, or use it to pay down debt. Thus, it is difficult to estimate 

how consumers will react to the windfall. Using the impacts of the 

2001 and 2008 tax cuts as a guide, we expect real consumer 

spending growth to pick up by two-tenths in both 2018 and 2019, to 

2.7 percent and 2.5 percent, respectively. The saving rate, which 

dipped three-tenths in November to the expansion low of 2.9 

percent, should trend up as a result of the tax bill. Thus, while the 

tax cut may not boost consumer spending substantially because 

some taxpayers will choose to save the windfall or use it to pay 

down debt, it would help provide a savings cushion for rainy days 

and strengthen household balance sheets.

The labor market ended 2017 on a relatively subdued note, with 

nonfarm payrolls increasing 148,000 in December, weakening from

the strong back-to-back gains following hurricane disruptions. A 

small net downward revision for the prior two months put the threemonth average gain at 204,000. The survey of households was also 

uninspiring. The unemployment rate and the labor force participation 

rate were unchanged at 4.1 percent and 62.7 percent, respectively, 

and the broadest measure of labor underutilization, the U-6 rate, 

edged up one-tenth to 8.1 percent.

-2%

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The Tax Bill Improves the Outlook

Actual Jan '18 forecast Dec '17 forecast

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Small Business Confidence Posts the Highest Annual Average Level on Record in 2017

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Personal Saving Rate (SA, %)

The Saving Rate Should Move Higher From the Expansion Low

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NFIB Small Business Survey (SA, %)

Small Businesses With Few or No Qualified Job Applicants Hits a Record High

Businesses with Few or No Qualified Applicants for Job Openings
© 2018 Fannie Mae. Trademarks of Fannie Mae. 1.10.2018 3 of 5

Other aspects of the establishment survey also disappointed. The average workweek was unchanged at 34.5 hours, and

average hourly earnings rose 0.3 percent from November and 2.5 percent from a year ago, near the lower end of the 2.4 

percent to 2.8 percent range witnessed throughout the year. We believe that wage gains will accelerate this year given a 

shortage of skilled labor. The December NFIB survey showed that the share of small business owners with few or no 

qualified applicants for open positions surged 10 percentage points to 54 percent—a record high. 

For all of 2017, the economy added 2.2 million jobs, marking the seventh straight year with over two million jobs created. 

We expect another year of more than two million in payroll gains this year, with an average monthly gain of 186,000, 

about 10,000 more than in our prior forecast. One bright spot in the December jobs report was the biggest monthly rise in 

residential construction employment of 2017, raising hopes for some supply relief for housing this year. 

 

The Fed Will Likely Remain Cautious

At the December Federal Open Market Committee (FOMC) meeting, the Federal Reserve raised the fed funds rate 25 

basis points. The Fed appears to be counting on modest, synchronized global growth to continue as they attempt to get 

some distance between a zero percent short-term rate and the current policy rate. The shrinkage of the balance sheet, 

another measure of monetary policy normalization, continues as expected. The Fed also released its updated Summary 

of Economic Projections (SEP), which revealed a slight upgrade for growth expectations for 2018 and 2019 and a lower 

unemployment rate forecast. While final details were not known when the FOMC met in December, the tax bill under 

consideration at the time was quite similar to the final enacted tax legislation. The updated SEP “dot plot” implied that 

FOMC members expect three rate hikes in 2018, the same as in the September projections. We believe that the Fed will

wait for evidence of increased inflationary pressure before responding with a faster pace of rate increases. We expect the 

Fed to hike in March and in September of this year; however, a third rate increase this year is quite possible.

Housing Roundup

The Tax Act will create winners and losers in the housing market. While the individual tax cut should boost housing 

demand by increasing disposable household income, the tax bill reduces the incentive for homeownership by doubling the 

standard deduction, reducing the mortgage debt cap on which homeowners may take a mortgage interest deduction to 

$750,000 from $1,000,000 (with loans made before December 14 being grandfathered in), and limiting SALT and property 

tax deductions to a total of $10,000. As a result, the bill will lead to 

substantially fewer itemized returns. 

Looking back, housing activity through November was upbeat 

across the single-family segment. Both single-family starts and 

permits rose in November to the highest levels in more than a 

decade, while homebuilder sentiment surged to an 18-year high in 

December. Through the first 11 months of 2017, single-family 

housing starts were 8.7 percent more than during the same period 

in 2016. Meanwhile, multifamily building has clearly peaked, as 

year-to-date multifamily starts through November were 8.2 percent 

below their 2016 level. 

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Annual Change in Total Nonfarm 

Employment (NSA, Millions)

The Economy Adds More than Two Million Jobs for the Seventh Consecutive Year

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Residential Construction Employment (SA, Month-over-Month Change, Thous.)

Pace of Residential Construction Hiring 

Increases Momentum at Year End

Note: Residential Construction Employment combines 

construction of buildings and specialty trade contractors

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'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 SAAR, Millions of UnitsSAAR, Millions of Units

New and Existing Home Sales Surge to Expansion Highs in November

Existing Home Sales New Home Sales (Right Axis)
© 2018 Fannie Mae. Trademarks of Fannie Mae. 1.10.2018 4 of 5

Existing home sales were also upbeat in November, rising for the 

third consecutive month to reach the strongest pace in nearly 11 

years. Meanwhile, new home sales surged to the highest level 

since July 2007. Year-to-date existing and new home sales through 

November were 1.4 percent and 9.0 percent higher, respectively, 

than during the corresponding period in 2016.

The principal problem facing the housing market, especially for the 

existing home segment, remains one of supply rather than demand.

The number of existing homes for sale in November was 9.7 

percent below the level a year earlier and has fallen year-over-year 

for 30 consecutive months. The months’ supply plunged to 3.4 

months, the lowest level since the inception of the series in 1999. 

We expect tight inventory will continue to restrain home sales this 

year, even with the positive income effect from the tax cuts. The tax 

bill could negatively affect home prices in the high-end market; however, this segment accounts for a very small share of

the total market and should have limited impact on overall home price appreciation. 

Mortgage rates will continue to support the housing market as we expect them to rise only modestly over the next year, 

averaging 4.1 percent in the fourth quarter of 2018, up from 3.9 percent in the fourth quarter of 2017. Total housing starts 

should increase about 5 percent in 2018, solely because of the single-family segment, as multifamily starts are projected 

to decline further. We expect total new and existing home sales to rise about 2 percent, similar to the gain through 11 

months of 2017. Total single-family mortgage originations should decrease about 5 percent this year to $1.73 trillion from 

an estimated $1.83 trillion in 2017, with a 7 percentage point decline in the refinance share to 31 percent in 2018.

 

For information on multifamily market conditions, read the January 2018 Multifamily Market Commentary.

Economic & Strategic Research (ESR) Group

January 10, 2018

For a snapshot of macroeconomic and housing data between the monthly forecasts, please read ESR’s Economic and 

Housing Weekly Notes

Data source for charts: Bureau of Labor Statistics, Bureau of Economic Analysis, National Federation of Independent Business, Census Bureau, 

National Association of REALTORS®, Fannie Mae Economic and Strategic Research

Opinions, analyses, estimates, forecasts and other views of Fannie Mae's Economic & Strategic Research (ESR ) Group included in these materials 

should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to 

change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, 

estimates, forecasts and other views on information it considers reliable, it does not guarantee that the information provided in these materials is 

accurate, current or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially 

2.1%

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Total Home Sales Single-Family Housing Starts Multifamily Housing Starts Year-over-Year % Change

Home Sales and Single-Family Building Should Grind Forward in 2018 and 2019

2017 YTD - November

2018 Forecast

2019 Forecast

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Single-Family Mortgage Originations (NSA, $Billions, 1-4 Units)

Mortgage Originations Are Expected to Shift Toward the Purchase Market

Purchase Refinance

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Inventory/Sales Ratio (Months) NSA, Year-over-Year % Change

Months' Supply of Existing Homes Falls to the Lowest Level on Record

Existing Homes Available for Sale Months' Supply (Right Axis)
© 2018 Fannie Mae. Trademarks of Fannie Mae. 1.10.2018 5 of 5

different results. The analyses, opinions, estimates, forecasts and other views published by the ESR group represent the views of that group as of the 

date indicated and do not necessarily represent the views of Fannie Mae or its management.

ESR Macroeconomic Forecast Team

Doug Duncan, SVP and Chief Economist Mark Palim, VP and Deputy Chief Economist

Orawin T. Velz, Director Frank Shaw, Economist 

Hamilton Fout, Director Rebecca Meeker, Business Analyst