Fed's long-term GDP outlook is dismal; the economy hasn't got the message yet (2023)

WASHINGTON, Aug 21 (Reuters) - After puzzling for years over the sluggish U.S. rebound from the 2007-2009 recession, the Federal Reserve had a reckoning at its policy meeting in September of 2016.

Because of poor productivity and population aging, typical U.S. economic growth of 2.5% or more annually was "not possible anymore" on a sustained basis, said John Williams, the current New York Fed president who at the time was head of the San Francisco Fed, according to transcripts of a session where policymakers cut their median long-term GDP growth outlook to 1.8%, continuing a roughly decade-long slide.

For the next three years and continuing on the other side of a world-altering pandemic, the U.S. has left that seeming constraint in the dust, with growth exceeding 1.8% in 21 of the 28 quarters since, including a period of 2.5% annual growth in the years between that 2016 Fed meeting and the onset of the coronavirus pandemic, and averaging 3% so far under President Joe Biden.

The pandemic, with its massive hit to growth in two of those quarters in 2020 and the multi-trillion-dollar government response that followed, clouds an understanding of emerging trends.

But when policymakers gather later this week for an annual Fed research symposium in Jackson Hole, Wyoming that will be focused on "structural shifts," they will have to grapple with an economy in deep flux - from U.S. labor force growth that has been better than anticipated, a manufacturing construction surge, changing global supply chains, continued high inflation, and, now, hints of improving productivity.

It's unlikely they'll abandon their muted view of U.S. economic potential. Slower population growth is wired into the U.S. outlook at this point, immigration remains a politically-charged issue, and better productivity, the other key driver of growth, is hard to anticipate.

Economists at investment firm BlackRock in essays this month pivoted towards an even harsher view of what they deemed "full-employment stagnation," with potential U.S. growth as low as 1% as the baby boom generation retires, inflation remains volatile, and worker shortages persist.

(Video) World Economic Outlook Update, July 2021

But policymakers have been surprised enough in recent years that a larger conversation is beginning - some of it couched in technical analysis of whether, for example, underlying interest rates have moved higher, some in the blunt observation that people keep behaving differently than the experts expect.

From September 2016 through 2019, for example, the U.S. labor force grew about twice as fast as the moribund 0.5% a year Fed staff saw as the likely trend, a pace sustained once the number of available workers recovered in 2022 from a pandemic-driven downturn to its prior high.

"The ability to pull people into the labor force ... was much higher than even advocates thought," said Adam Posen, a former Bank of England policymaker who is now president of the Peterson Institute for International Economics in Washington. He called the U.S. central bank's misreading of the issue "a major failure" that can mar analysis of where the economy stands.


For available workers to add to economic output, however, they have to have something to do. Since 2016, policies from the vastly different Trump and Biden administrations have combined in a sort of accidental complementarity to keep both job and economic growth above the Fed's estimate of potential.

Under former President Donald Trump, corporate tax cuts and other changes pushed growth higher in ways that surprised the central bank, while under his successor, President Joe Biden, an array of energy- and technology-related industrial policies, with infrastructure spending also in the pipeline, has triggered a boom in manufacturing construction. Both presidents added to pandemic recovery programs that may still be boosting consumer and local government spending.

Trump's pre-COVID years ended with the unemployment rate at 3.5% in February 2020; it has been essentially at that level since March of 2022 under Biden, with the economy still adding roughly 200,000 jobs per month.

It isn't sustainable, said Dana Peterson, chief economist at the Conference Board think tank. Driven by government tax and spending policies, the run of above-potential growth doesn't reflect any underlying shift in economic performance - at least not yet - and now faces two obstacles, she said.

One is rising public debt. While some of the money borrowed in recent years could lift economic performance over time with improved infrastructure or other projects, Peterson said the net outcome is likely a drag on growth and private investment.

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The other is the Fed. The central bank is fighting an outbreak of high inflation, largely linked to the pandemic and the response to it, with high interest rates designed precisely to force economic growth below trend.

Fed Chair Jerome Powell is scheduled to speak at the Jackson Hole conference on Friday.

The Fed has raised interest rates by 5.25 percentage points since March 2022 in its bid to tame the surge in inflation, but so far it has not seen as much response from the economy as expected. U.S. output grew at a 2.4% annual pace in the second quarter, and may be poised for a strong third quarter as well. While many economists feel a slowdown is coming, the longer growth remains robust the more the Fed may feel it needs to lean on the economy.

Median Fed policymaker projections of potential U.S. economic growth have slid from a level around 2.5% a decade ago to 1.8% as of June 2023, when the last projections were issued.

"In the next six to 12 months you probably have a recession and that is a function of the Fed," the Conference Board's Peterson said. "After that is done we will shift to a phase of slower growth."


An alternative view harkens to former Fed Chair Alan Greenspan's hunch in the mid-1990s that quickening economic growth stemmed from technological improvements that paved the way for workers to produce more per hour, allowing the economy to grow faster without raising inflation. Under pressure from colleagues to raise interest rates as the economy accelerated, Greenspan resisted and accommodated the expansion instead of fighting it.

At the onset of the pandemic some economists suggested that changes in the application of technology or the shift to remote work might boost worker output.

(Video) The Economic Outlook for 2022

As of last year's Jackson Hole conference, San Francisco Fed economist and productivity expert John Fernald and his colleague Huiyu Li said in a paper that while the pandemic had rearranged some industry trends, it had not changed the underlying "slow-growth regime" of productivity increasing about 1.1% a year. By contrast, productivity rose about 2.5% a year from 1995 to 2005, they noted.

Yet productivity jumped by a 3.7% annualized rate in the second quarter of this year, and expectations for a strong boost in the current three-month period "offer glimmers of hope that trend productivity is picking up," Michael Feroli, chief U.S. economist at JPMorgan, wrote this month. He concluded the change "could have some legs," with rising investment in software and information processing possibly pointing to the diffusion of artificial intelligence applications.

It may not matter much to the Fed with inflation still running high. But it could help economic growth continue even as prices cool, another prop for the "soft landing" the Fed hopes to engineer and possible evidence of rising potential.

"It is very hard to extrapolate recent years into any reassessment of longer-term conditions," said Antulio Bomfim, head of global macro for the global fixed income group at Northern Trust Asset Management and a former senior adviser to Powell. But "having said that ... I would see the balance of risks as being to the upside."

Reporting by Howard Schneider; Editing by Paul Simao

Our Standards: The Thomson Reuters Trust Principles.

(Video) The US Economic Outlook and Implications for Monetary Policy

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Howard Schneider

Thomson Reuters

(Video) U.S. Economic Outlook and Implications for Monetary Policy

Covers the U.S. Federal Reserve, monetary policy and the economy, a graduate of the University of Maryland and Johns Hopkins University with previous experience as a foreign correspondent, economics reporter and on the local staff of the Washington Post.


Why does GDP not tell us about the economy? ›

Real GDP. One thing people want to know about an economy is whether its total output of goods and services is growing or shrinking. But because GDP is collected at current, or nominal, prices, one cannot compare two periods without making adjustments for inflation.

Why GDP is no longer the most effective measure of economic success? ›

GDP is a useful indicator of a nation's economic performance, and it is the most commonly used measure of well-being. However, it has some important limitations, including: The exclusion of non-market transactions. The failure to account for or represent the degree of income inequality in society.

How long does GDP have to be negative for a recession? ›

A recession is a significant, widespread, and prolonged downturn in economic activity. A common rule of thumb is that two consecutive quarters of negative gross domestic product (GDP) growth mean recession, although more complex formulas are also used.

What is the economic outlook for the US GDP? ›

GDP growth is decelerating; while GDP increased by about 1.5% annualized in the first half of 2023, it's expected to dip to 0.5% annualized in early 2024. Source: Bureau of Economic Analysis, Bureau of Labor Statistics, J.P. Morgan.

Why GDP is not a good indicator of economic welfare? ›

GDP is an indicator of a society's standard of living, but it is only a rough indicator because it does not directly account for leisure, environmental quality, levels of health and education, activities conducted outside the market, changes in inequality of income, increases in variety, increases in technology, or the ...

What are the four things GDP does not tell us? ›

In truth, “GDP measures everything,” as Senator Robert Kennedy famously said, “except that which makes life worthwhile.” The number does not measure health, education, equality of opportunity, the state of the environment or many other indicators of the quality of life.

Why is GDP a flawed measure? ›

Many key goods, including peacefulness, environmental protection or family bonding, are not measured in GDP because they do not involve transactions. In fact, GDP includes pollution, crime, the health costs of cigarettes and environmental disasters as 'growth' because they generate spending.

Which country has highest GDP? ›

With a GDP of more than 20 trillion dollars, the United States of America is the world's largest economy.

Why is GDP not a good measure of sustainable development? ›

For example, GDP per capital reveals nothing concerning energy and material interactions with the environment. GDP is also not considered a good measure of sustainable consumption because it does not allow for the capital used up in the production process.

How long will 2023 recession last? ›

Earnings Recession in 2023 to Transition to Strong Recovery in 2024. Morgan Stanley Research strategists think U.S. corporate earnings could decline 16% in 2023 but stage a comeback in 2024 and 2025.

Is the US economy in trouble? ›

This year's results so far show an economy that has stabilized at a modest rate of expansion. The current level is slower than the annualized growth rate of 5.9% recorded in 2021, which represented the fastest rate of growth in a calendar year since 1984. GDP increased at a much more moderate 2.1% in 2022.

Who benefits from a recession? ›

A recession may provide for a real cash savings on real estate, for personal or business benefit. Businesses that lease may find that landlords are willing to negotiate on terms and provisions during this time period, as they grow concerned about a protracted downturn and increased vacancies.

What is the biggest economic problem for the US economy 2023? ›

This outlook is associated with numerous factors, including, elevated inflation, high interest rates, dissipating pandemic savings, lower government spending, and the resumption of mandatory student loan repayments. We forecast that real GDP growth will slow to 1.9 percent in 2023, and then fall to 0.5 percent in 2024.

Will the US economy get better? ›

The tightness of financial conditions and the negative impact on growth will peak in late 2023 and early 2024, and we think the pace of recovery will be gradual. Annual GDP growth will not return to trend until 2025-2026.

What state is the US economy in right now? ›

How is the US economy doing? US GDP increased 2.1% in 2022 after increasing 5.9% in 2021. Year-over-year inflation, the rate at which consumer prices increase, was 6.5% in December 2022.

Why do some economists argue that GDP is an ineffective economic measure? ›

GDP only counts goods that pass through official, organized markets, so it misses home production and black market activity. This is a big omission, particularly in developing countries where much of what's consumed is produced at home (or obtained through barter).

What are some of the reasons why GDP should not be considered an effective measure of the standard of living in a country quizlet? ›

List some of the reasons why economists should not consider GDP an effective measure of the standard of living in a country. GDP doesn't measure things like disease rates, life expectancy, happiness, income inequality environmental degradation and any number of other aspects that contribute to the standard of living.


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