JPMorgan Sub-New Normal Growth Seen Vexing Next Fed ChiefRich Miller and Aki Ito
The next chairman of the Federal Reserve faces an alarming possibility: the new normal for the economy is even worse than advertised.
The long-run potential growth rate for gross domestic product has slid to around 1 3/4 percent per year, from an average rise in GDP of 2 1/2 percent since 1990, according to economists at JPMorgan Chase & Co., the largest U.S. bank by assets. That would be the lowest level since World War II and below the 2 percent mark that Pacific Investment Management Co. pegged as the new normal for the economy.
The “U.S. future isn’t what it used to be,” said Michael Feroli, chief U.S. economist at JPMorgan in New York. Declining productivity gains and a slower expansion of the labor force “should limit the U.S. average growth pace” in the long run.
As they gather for the Fed’s annual conference at Jackson Hole, Wyoming, economists and central bankers are aware of the implications. A slower potential growth rate -- the top speed at which the economy can expand without heating up inflation -- means the Fed would have to tighten credit quicker if growth does gain momentum. Slower growth would limit the ability of businesses to boost profits and workers to win pay increases and make it tougher to reduce the federal budget deficit.
“It’s hard to be optimistic,” said Edmund Phelps, a professor at Columbia University in New York and winner of the Nobel Prize in Economic Sciences in 2006. “There’s less innovation and less stimulation going on.”
Fed Chairman Ben S. Bernanke said in November that the financial crisis and its aftermath had probably “reduced the potential growth rate” of the economy, as discouraged workers dropped out of the labor force and businesses held back on investment.
He voiced hope though that those drags on growth wouldn’t last long. “The effects of the crisis on potential output should fade as the economy continues to heal,” Bernanke, who isn’t attending the Jackson Hole meeting, said in a Nov. 20 speech in New York.
Lawrence Summers, whom President Barack Obama has mentioned as a candidate to succeed Bernanke, told a Drobny Global Advisors conference in April that he expected the economy to gain momentum in the coming 18 months. If that failed to happen, however, it would suggest that potential growth is lower and more in line with the economy’s sub-par performance in recent years, he said, according to a transcript of his remarks.
Since the recession ended in June 2009, the U.S. has grown at an average annual rate of 2.2 percent. GDP in the second quarter rose at a 1.7 percent pace, according to a preliminary estimate by the Commerce Department.
The Fed’s 19 policy makers peg the longer-run growth rate of the economy at anywhere from 2 to 3 percent, data released by the Fed on June 19 showed. The central tendency estimate, which excludes the three highest and lowest projections by the policy makers, was 2.3 percent to 2.5 percent.
A fall in the economy’s cruising speed wouldn’t preclude it from expanding faster than that rate for a while. Feroli, a former staff member at the Fed, forecasts that GDP will increase 2.5 percent next year after rising 1.5 percent in 2013.
What it would mean is that average growth over an extended period couldn’t exceed the potential rate -- the sum of the growth of the labor force and of worker productivity. And on both those fronts, Feroli sees signs of weakness.
He said the work force will expand more slowly over the next five years as aging baby boomers retire and stricter border controls limit immigration. He predicted that labor supply will expand 0.5 percent per year, down from a 1.5 percent annual average since 1950. That forecast is in line with one made by the Congressional Budget Office in February.
Feroli acknowledged that his estimate of trend productivity growth is more controversial. He puts that at 1.25 percent per year, compared with the CBO’s 1.6 percent projection and an average 1.7 percent since 1950.
There are two strands to Feroli’s forecast. He argues that not only have advances in information technology slowed, but companies aren’t increasing spending on IT or on research and development as much as they did in the past.
He bases his first contention on data from the government on prices for technology equipment and software. Those prices are adjusted to take account of product improvements, such as gains in computing power in recent years. That means the faster the adjusted prices fall, the more technology is advancing.
The trouble, Feroli said, is that those price declines are moderating. Computer prices are trending lower at an annual rate of around 3 percent, compared with drops of as much as 25 percent in the late 1990s, according to calculations by JPMorgan using government data.
Partly as a result of the slowdown in innovation, companies aren’t plowing as much money into IT investment as before, he said. Adjusted for inflation, the stock of high-tech equipment and software in the economy increased at annual rate of 3.1 percent from 2009 to 2011, the latest figure available, down from an average increase of 8.5 percent over the 25 years through 2008. Feroli reckoned that growth in the capital stock is still running below 4 percent.
Tech companies are feeling the pinch. Cisco Systems Inc., the biggest maker of networking equipment, said on Aug. 14 that it’s cutting about 5 percent of its workforce after issuing a fiscal first-quarter sales forecast that missed most analysts’ estimates.
“This recovery is more mixed and inconsistent than the others I’ve seen,” John Chambers, chief executive officer of the San Jose, California-based company, told analysts in a conference call.
Feroli’s take on productivity growth echoes that of Northwestern University professor Robert Gordon. He predicted last year that between 2007 and 2027, GDP per capita will grow at the slowest pace of any 20-year period in U.S. history going back to George Washington.
Other economists, including Mohamed El-Erian, chief executive officer of Pimco, Kenneth Rogoff of Harvard University and Nobel laureate Michael Spence, aren’t as pessimistic.
“The American economy still has great strengths in terms of innovation,” said Spence, a professor at New York University’s Stern School of Business. “It’s very flexible and adjusts relatively quickly.”
The financial crisis has crimped public and private research and that’s having an impact on productivity, Rogoff, a former chief economist at the International Monetary Fund, said in an e-mail.
“But this transitory effect does not undo the longer-run interaction of globalization and technology which continues to drive innovation and longer-run productivity growth,” he added.
Two of Feroli’s former colleagues at the Fed, Stephen Oliner and Daniel Sichel, aren’t as downbeat as he is. They put the potential growth rate of GDP at around 2 percent. Oliner, now at the American Enterprise Institute in Washington, said the government data may not be catching all of the technological improvements in computers because increasingly they are manufactured overseas.
The price of personal computers isn’t a useful way to judge the productivity of technology because they are more and more being supplanted by handheld devices, said Brian Lillie, chief information officer of data center operator Equinix Inc. of Redwood City, California.
“Almost all of the applications we’re developing for internal use are for smart phones and tablets,” rather than PCs, he said.
Sichel, now a professor of economics at Wellesley College in Massachusetts, said the U.S. may be in “a pause period between the PC era and what comes next, with handheld devices, massive connectivity and big data.” Such a second stage in innovation could lift the trend growth rate of the economy to about 2.75 percent, he added.
That would still be short of the 3.4 percent annual growth that the U.S. enjoyed during the productivity boom from 1995 to 2004, when Alan Greenspan headed the Fed. Given the alternative mapped out by Feroli, it would be welcome news nonetheless for the next central bank chief.