Monetary Policy & Inflation | US
The economy is set to experience four shocks in October: an auto strike, government shutdown, onset of student debt repayments, and the end of tax relief.
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A government shutdown is likely but, in my view, is the least impactful shock to hit the US economy next month. I expect it could last about 10 days, which makes it unlikely to impact growth as the government typically makes up for suspended payments and purchases of goods and services. Past shutdowns have not been clearly associated with growth slowdown as government funding is one of many factors driving growth and is typically not the most important one.
Student loan repayments will restart in October. A detailed analysis of the data suggests the impact on consumption is likely to be limited.
Debt repayments can be broken down between interest and principal repayments.
Interest: Only interest directly impacts spending and GDP since principal repayments are a financial transaction (more on this below). The CBO estimates the cost to the budget of the student debt moratorium (i.e., the foregone interest) to be about $4.3bn/month. Annualized, this represents about $50bn, or 0.25% of total household disposable income (Table 1; since only one in six adult Americans has student loans, the amount per actual borrower is higher.
In addition, it is unclear whether households will accommodate this additional outlay through lower consumption or lower savings. The data is ambiguous, not least because savings are more volatile than interest payments (Chart 1). Interest payments seem to have a weak negative correlation with savings (i.e., higher interest payments could be accommodated with lower savings). In any event, the impact is likely to be limited.
Principal: In addition to interest, borrowers will have to restart principal repayments. In a perfect, frictionless world this would have no impact on net worth and consumption since borrowers would be reducing their assets and their liabilities by an equivalent amount.
In reality, cash-strapped borrowers could try to offset the repayments by saving more to maintain their cash holdings. That is, while principal repayments would not directly impact consumption, they could impact it indirectly through their impact on the household savings rate.
I am unsure how important this is. First, the amount involved is relatively small: based on the average interest rate of 3.5% (implied by the CBO cost estimate) and the de facto average repayment period of 20 years, yearly principal repayments would represent on aggregate $60bn a year. Second, households still have capacity to borrow: non-student consumption borrowing has been rising since March 2021 (Chart 2). Cash holdings also remain high relative to income and assets.
Additional debt relief: This month, the Biden administration announced a new, more generous IDR (Income Driven Repayment) plan that provides new relief to borrowers. The CBO estimates the NPV of the new IDR will cost the budget an additional $230bn over 2023-33. Most importantly, borrowers delinquent for more than 75 days will be automatically enrolled in the new IDR plan. This will further lighten the impact of the moratorium ending.
The automotive strike could materially impact inflation. About 30,000 workers have been on strike for the past two weeks. The strike is riskier for inflation than for GDP for several reasons.
First, the share of car manufacturing in GDP or employment, at about 1%, is much smaller than the weight of cars in the CPI, about 8% (Table 2).
Second, the strikers have announced that they would be strategic and target specific production facilities rather than implement blanket work stoppages. This suggests a greater impact on car production (i.e., supply) than on employment and wages in car manufacturing (i.e., demand).
Third, at the retail level, the inventory-to-sales ratio for motor vehicles and parts is still well below pre-pandemic levels, although it is rising (Chart 3). Supply disruptions could prevent dealers from further rebuilding their inventories and trigger a rebound in new car prices.
Long-term, if the strike succeeds, it could have a demonstrable effect and support a broad-based acceleration of wage growth either through further industrial action or the threat of it.
Finally, there is a risk of bunching tax payments in October. Since February 2023, the CBO has been revising down its estimates of FY2023 tax receipts (Table 3). In its review of the July 2023 budget, the CBO stated that it expects receipts to be about $400bn lower than previous projections, without providing much details other than: ‘The reasons for the difference will be better understood as additional information becomes available; one factor may be smaller collections of taxes on capital gains and other types of income.’
The tax collection data shows that the shortfall is mainly with individual income tax. Furthermore, the daily Treasury data on deposits and withdrawals of operating cash shows the shortfall is mainly with non-withheld income tax payment and started in April, when most individuals file and pay their taxes (Chart 4). By contrast, withheld individual tax payments are rising in line with employment and wages.
October-August non-withheld individual income tax receipts are about $300bn lower than the same period last year. The shortfall could reflect tax relief linked to extreme weather. Unlike 2022, when weather-related tax relief consisted mainly of postponing tax payments within FY2022, in 2023, tax payers in states representing about 30% of federal tax revenues have been allowed to file and make FY2023 tax payments by 15 October (i.e., in FY2024).
If I am correct, there could be a bunching of tax payments around mid-October that could negatively impact consumption. That said, I do not expect the impact to last given strong growth and household balance sheets.
Of the four shocks likely to hit the US economy next month, the car strike could be the most impactful through its effect on inflation. By contrast, I do not expect a government shutdown, student debt repayments or the end of tax relief to have a lasting impact on growth.
Higher inflation risks mean the Federal Reserve (Fed) could hike more than it and the market expect. This is not a 2023 risk as inflation is likely to behave in line with the SEP forecast, but rather a 2024 risk. The two 2024 cuts the Fed expects are predicated on core PCE slowing to 2.6% by end-2024, from an expected 3.7% in 2023. If inflation proves stickier than the Fed expects, it is likely to remove the cuts and could actually restart gradual hikes around mid-year.
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