Wednesday, April 11, 2018

Real GDP Growth: Hard To Get Back to Old Normal

In a 4/6 speech, newly appointed Fed Vice Chairman John Williams matter-of-factly stated: “Last year real gross domestic product, or GDP, increased 2.6 percent. This is a solid performance. Importantly, it’s above the trend growth rate, which I peg at about 1¾ percent.”

I was surprised by his comment that the trend in real GDP is only 1.75%. That certainly is at odds with the predictions of President Donald Trump and his supply-side advisers, who believe that their policies will boost real GDP growth up to the old normal of 3.0% and even 4.0%. I have been expecting more of the same, i.e., 2.0%-2.5%.

Williams referenced a 10/11/16 FRBSF Economic Letter titled “What Is the New Normal for U.S. Growth?” by John Fernald. Sure enough, the article starts by stating: “Estimates suggest the new normal for U.S. GDP growth has dropped to between 1½ and 1¾%, noticeably slower than the typical postwar pace.” The article explains the reasoning behind this lackluster outlook for real GDP as follows:

“This estimate is based on trends in demographics, education, and productivity. The aging and retirement of the baby boom generation is expected to hold down employment growth relative to population growth. Further, educational attainment has plateaued, reducing the contribution of labor quality to productivity growth. The slower forecast for overall GDP growth assumes that, apart from these effects, productivity growth is relatively normal, if modest—in line with its pace for most of the period since 1973.” Here’s more:

(1) Labor force growth. “[T]he population is now growing relatively slowly, and census projections expect that slow pace to continue. Second, these projections also suggest the working-age population will grow more slowly than the overall population, reflecting the aging of baby boomers. Of course, some of those older individuals will continue to work. Hence, the Congressional Budget Office (CBO) projects the labor force will grow about ½% per year … over the next decade—a little faster than the working-age population, but substantially slower than in the second half of the 20th century.”

(2) Productivity growth. The article is much more pessimistic (or perhaps realistic) about the outlook for productivity growth than are today’s supply-siders. Fernald concedes: “The major source of uncertainty about the future concerns productivity growth rather than demographics. Historically, changes in trend productivity growth have been unpredictable and large.” Nevertheless, he estimates that the new normal trend growth rate in real GDP is 1.6%, implying that productivity won’t grow much faster than 1.0%.

(3) Information technology. But won’t the IT revolution boost productivity? It hasn’t been doing so in recent years. Fernald observes: “Starting around 1995, productivity growth was again exceptional for eight or nine years. Considerable research highlighted how businesses throughout the economy used information technology (IT) to transform what and how they produced. After 2004, the low-hanging fruit of IT had been plucked.”

Again, he concedes: “Looking ahead, another wave of the IT revolution from machine learning and robots could boost productivity growth. ... But, until such a development occurs, the most likely outcome is a continuation of slow productivity growth.”

For more on technology and productivity, see Chapter 3 of my new book, Predicting the Markets: A Professional Autobiography.

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