The US Federal Reserve finally came to terms with the slow U.S. recovery from the 2007–2009 recession during its policy meeting in September 2016. This followed years of consternation.

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

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 start of the coronavirus pandemic, the U.S. has left that apparent constraint in the dust for the following three years and continuing on the other side of a world-changing pandemic. Growth has averaged 3% so far under President Joe Biden.

Understanding of developing trends is hampered by the pandemic, which had a significant negative impact on growth in two of those quarters in 2020 and the multi-trillion dollar government reaction that followed.

The U.S. labour force growth has been better than expected, there has been a surge in manufacturing construction, global supply chains are changing, there is still high inflation, and now there are hints of improving productivity. However, when policymakers meet later this week in Jackson Hole, Wyoming for an annual Fed research symposium that will be focused on “structural shifts,” they will have to deal with an economy that is in profound flux.

They are unlikely to change their cautious assessment of American economic prospects. At this point, the U.S. prognosis includes slower population growth, immigration is still a contentious topic, and greater productivity—the other major factor driving growth—is difficult to predict.

In essays published this month, economists at the investment firm BlackRock shifted to a harsher assessment of what they called “full-employment stagnation,” with possible U.S. growth as low as 1% due to the retirement of the baby boom generation, fluctuating inflation, and ongoing labour shortages.

But in recent years, policymakers have been sufficiently taken aback that a larger discussion is starting. Some of it is couched in technical analysis of whether, for instance, underlying interest rates have moved higher, while others are simply the blunt observation that people continue to behave in ways that are contrary to what experts would predict.

For instance, from September 2016 through 2019, the U.S. labour force increased roughly twice as quickly as the dormant 0.5% per year Fed employees believed to be the anticipated pattern. This growth rate was maintained once the number of available workers rebounded from a pandemic-driven decline to reach its previous high in 2022.

“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.

However, available workers must have a job in order to contribute to economic activity. Since 2016, measures from the diametrically opposed Trump and Biden administrations have worked in unison to maintain economic and job growth above the Fed’s projected potential.

The central bank was taken aback by the corporate tax cuts and other changes made under former President Donald Trump, while manufacturing construction has soared under his successor, President Joe Biden, thanks to a variety of energy and technology-related industrial policies and planned infrastructure spending. Programmes for pandemic recovery that were expanded under both presidents may still be encouraging consumer and local government spending.

The unemployment rate during Trump’s pre-COVID years was 3.5% in February 2020; under Biden, it has virtually remained at that level through March 2022, with the economy continuing to add about 200,000 jobs per month.

Dana Peterson, chief economist at the Conference Board think tank, declared that it is not sustainable. The run of above-potential growth, which is being driven by government tax and spending programmes, is currently facing two challenges since it doesn’t yet represent any underlying change in economic performance, she added.

Increasing public debt is one. While some of the money borrowed in recent years might help economic performance in the future with better infrastructure or other projects, according to Peterson, the overall effect is probably going to be a drag on growth and private investment.

The Fed is the other. With high interest rates that are specifically intended to drive economic growth below trend, the central bank is battling an outbreak of high inflation that is partly tied to the epidemic and the reaction to it.

On Friday, Jackson Hole conference speaker Jerome Powell, the chair of the Fed, is slated to talk.

In an effort to curb the inflation spike, the Fed has increased interest rates by 5.25 percentage points since March 2022, but so far the economy has not responded as much as anticipated. The United States’ output expanded at a 2.4% annual rate in the second quarter, and a strong third quarter may be on the horizon.

While many analysts predict a recession, the Fed may feel more compelled to support the economy the longer growth remains strong.

The median forecast for prospective U.S. economic growth made by Fed policymakers has fallen from a level of roughly 2.5% a decade ago to 1.8% as of June 2023, when the most recent predictions were released.

“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 alternate perspective recalls former Fed Chair Alan Greenspan’s suspicion in the middle of the 1990s that accelerating economic growth was the result of technology advancements that enabled workers to produce more per hour, enabling the economy to grow more quickly without increasing inflation. As the economy grew faster, Greenspan was under pressure from colleagues to raise interest rates, but he refused and decided to accept the expansion rather than fight it.

Some economists hypothesised at the start of the epidemic that improvements in the way technology is applied or a move towards remote employment may increase worker output.

John Fernald, an economist with the San Francisco Fed and an expert on productivity, and Huiyu Li stated in a paper that as of last year’s Jackson Hole conference that while the pandemic had changed some industry trends, the underlying “slow-growth regime” of productivity increasing by about 1.1% a year had not been altered. In contrast, they found that from 1995 to 2005, production increased by roughly 2.5% annually.

However, projections for a significant increase in the coming three months “offer glimmers of hope that trend productivity is picking up,” Michael Feroli, chief U.S. economist at JPMorgan, wrote this month. Productivity increased by a 3.7% annualised rate in the second quarter of this year.

After saying that the move “could have some legs,” he pointed out that growing investment in software and information processing may indicate the spread of applications utilising artificial intelligence.

Given that inflation is still high, the Fed may not give it any consideration. However, it may contribute to economic growth even as prices decline, providing yet another pillar for the “soft landing” the Fed seeks to design as well as potential proof 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.”

(Adapted from Reuters.com)

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