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Posted in General.
The US Federal Reserve, perennial optimists on all things growth-related, sneakily have been cutting their long-run GDP forecasts. An oft-repeated (though unverified) claim is that the Fed has never once in their 101-year history correctly predicted a recession more than 1 year out. They have to cheerlead; I get that. And yet, knowing they are necessarily biased, the Fed still has not raised their long-term GDP forecast for the US a single time since November of 2009. On the contrary, they cut it 8 times, now down to a measly 2.15%:
So what do they see that’s forcing them to tacitly acknowledge that 2% is the new 4%? Their intense focus on the health of the labor market, potential slack versus building wage pressure, etc., is likely revealing the precursors to a larger discussion about the future size and productivity of the US labor force. The evolution of these two factors is of critical importance for potential growth in the future, and the Fed is acutely aware of the disappointing outlook for both.
From a labor perspective, GDP growth can only arise from two sources: growth in total hours worked, or growth in productivity (the output per hour worked). GDP growth is the sum of these two. Workers can vary the number of hours they work (the length of the work week) but generally a durable trend higher in the number of hours worked arises from growth in the working population, rather than workers working longer. Productivity on the other hand is affected by numerous factors, e.g., technological innovation, and investments in both physical productive machinery as well as workforce training. If I could pick, productivity growth is the more desirable way to achieve economic growth, because gains in productivity typically lead to higher living standards for the economy. To the extent each worker-hour produces more real output, then wages can rise in real terms without necessarily creating inflation pressure. Household purchasing power increases.
Unfortunately, the US is far from utopic in either variable. The working population is under a two-pronged assault. First, the Labor Force Participation Rate (LFPR) has declined through the recovery to a 37-year generational low. This trend depicts a shrinking portion of the working-age population who are working or seeking work. The debate about how much of this decline is structural is ongoing, but it’s pretty clear at least some of it is. The second threat to the working population is the looming slow-down in growth in the number of people who are within the working-age cohorts. The Census Bureau recently released their latest National Population Projections out to 2060.* In that report, growth in the number of 18-64-year-olds is projected to halve, from 1.10% annually in the decade ending 2010, to 0.40% between now and 2020, without ever really recovering (Chart 2). (This analysis is inclusive of the contribution from immigration).
Recent experience with productivity has been equally uninspiring. The last two quarters have printed ‑2% or so, and the average run rate has been stubbornly stable at a (lame) 0.7%-0.8% throughout the recovery (chart below). Importantly however, the future of productivity growth in the US—good or bad—is murkier than the demographic trends of the labor force. There are well-known defeatists out there who say productivity gains from industrial, healthcare, and digital innovations over prior generations are not repeatable. That’s not my view, but it’s also not immediately clear where future gains might come from or the structural reforms that should be undertaken to boost this engine of economic improvement. Government lending for tertiary education was a promising reform in this regard, but the impact on collective productivity has not been felt, as output for those left behind has been dropping faster than the rise for those who graduate.**
The simple math is clear: assuming the LFPR merely stops declining (0.0% growth), the working age population grows as anticipated at 0.40%, and productivity maintains its 0.8% average run-rate, medium-term potential real GDP growth is 0.0% + 0.4% + 0.8% = 1.2%. Point being, the Fed’s seemingly lackluster forecast of 2.15% already includes a fair amount of rebound in the LFPR and/or run-rate productivity. I don’t think their optimism is misplaced, but it’s still optimistic.
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