Fed Reveals New Concerns About Long-Term U.S. SlowdownRich Miller
Federal Reserve Chairman Ben S. Bernanke and his colleagues are suffering through their own form of cognitive dissonance: revealing new concerns about the economy’s long-term prospects even as they forecast faster growth in 2014.
Worker productivity, a key component of an economy’s health, has risen at an annual clip of 1 percent during the last four years, as the U.S. has struggled to recover from the worst recession since the Great Depression. That’s less than half the 2.2 percent average gain since 1983, according to data from the Labor Department in Washington.
“Slower growth in productivity might have become the norm,” the central bankers noted at their Oct. 29-30 meeting, according to the minutes released last week. That’s a switch from past comments by Bernanke that the deceleration probably was temporary and would end as the expansion continued.
A combination of forces may be at work. Chastened by the deep economic slump, corporate executives have reduced spending plans for factories, equipment, research and development. Startup businesses have been held back as would-be entrepreneurs find it harder to get financing from still-cautious lenders. And out-of-work Americans have seen their skills atrophy the longer they’re without jobs.
“We’re in a slow-growth period of unknown duration,” said Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel prize in economics.
In his latest book, “Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge and Change,” Phelps argues that the U.S. has become sclerotic as entrenched corporate interests have stifled innovation.
A lasting decline in the growth of productivity, or nonfarm business output per employee hour, would be bad news for the economy. Its potential -- the ability of the U.S. to expand over an extended period without generating inflation -- is determined by the sum of growth in the labor force and of productivity. A slowdown in the latter would limit how fast the U.S. can develop in the future.
That, in turn, would have far-reaching implications for policy makers, company executives, working Americans and investors. Fed officials would need to be more alert to inflation risks if growth picked up. Lawmakers would face even more difficulties reducing the budget deficit because tax receipts would be lower. Companies might have to settle for reduced revenue, employees for smaller paychecks and investors for diminished returns as a result of the slower expansion.
“The expected future return of equities is about 4 percent a year” over the next decade, Ray Dalio, founder of Bridgewater Associates LP, a $150 billion hedge fund based in Westport, Connecticut, said at a Nov. 12 DealBook conference in New York.
U.S. stocks have gained about 25 percent annually, including dividends, since reaching a 2009 low, as the Fed has kept its benchmark interest rate near zero and corporate profits have risen.
Northwestern University Professor Robert Gordon has argued that the spurt in productivity associated with the computer and Internet revolution is over and as a result, the U.S. will be consigned to a long period of “dismal” growth. He predicted last year that between 2007 and 2027, gross domestic product per capita will rise at the slowest pace of any 20-year period in U.S. history going back to George Washington.
“We had low productivity in the 1970s and 80s, and it certainly wasn’t a great time for the economy,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. Consumer-price inflation topped out at 14.8 percent in 1980, while unemployment hit 10.8 percent in 1982.
The Fed already scaled back its estimates of the economy’s potential to expand. Central bankers now peg the underlying growth rate at 2.1 percent to 2.5 percent, according to projections released Sept. 18. That’s down from the 2.4 percent to 3 percent they saw in April 2011.
Based in part on the minutes, Feroli said policy makers are becoming reconciled to the possibility that the long-run rate is even lower. The former Fed researcher puts it at 1.75 percent and blames restrained capital spending and ebbing computer innovation for the slowdown.
Demand for non-defense capital goods excluding aircraft -- a proxy for future business investment in computers, electronics and other equipment -- declined 1.2 percent in October after falling 1.4 percent the previous month, the Commerce Department reported today in Washington. It was the first back-to-back decrease in a year.
In a Nov. 20, 2012, speech in New York, Bernanke said the financial crisis and its aftermath probably “reduced the potential growth rate” as discouraged workers dropped out of the labor force and businesses held back on investment.
He voiced hope, though, that these drags on expansion wouldn’t last long. “The effects of the crisis on potential output should fade as the economy continues to heal,” he said.
A fall in the economy’s cruising speed wouldn’t preclude it from expanding faster than this rate for a while. It just means it couldn’t do so for a long time without overheating.
A number of Fed policy makers forecast growth will pick up in 2014 as the impact of higher taxes and reduced government spending fades. Gross domestic product will rise 1.7 percent this year, according to the median forecast of private economists surveyed this month by Bloomberg.
Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, predicts growth of 2.5 percent to 3 percent next year. Charles Plosser, head of the Philadelphia Fed, has said he anticipates growth at “around 3 percent.”
Such a scenario argues for investors to hold more stocks than bonds now, according to Allen Sinai, chief executive officer of Decision Economics Inc. in New York. Sinai, who sees growth accelerating to 2.8 percent in 2014, recommended a portfolio mix of 80 percent equities and 20 percent bonds in a Nov. 18 note to clients.
Bernanke has portrayed the past few years’ deceleration in productivity as temporary. In an argument also espoused by Fed Vice Chairman Janet Yellen, nominated to succeed him next year, he suggested companies were forced to add workers even though economic growth was slow because they cut payrolls so much during the recession. According to this line of reasoning, the additional employees depressed productivity below its trend level in the short run after it climbed an unusually elevated 5.5 percent in 2009.
The trouble with Bernanke’s argument is that it looks “a little past its sell-by date” the longer productivity stays low, Feroli said.
Alan Blinder, who co-wrote a book with Yellen and is himself a former Fed vice chairman, says he’s concerned.
“Taking the Alfred E. Neuman view, what we’re experiencing is a give-back of the very surprising productivity gains” seen during the recession, he said, referring to the Mad Magazine character famous for saying “What, me worry?”
Blinder, now a professor at Princeton University in New Jersey, said he’s 65 percent convinced this is what’s going on. “The other 35 percent of me is puzzled by how low productivity has been and worried it might continue.”
Former Treasury Secretary Lawrence Summers has theorized the U.S. might be stuck in a “secular stagnation” that even zero-percent interest rates can’t solve. The lesson from the crisis is “it’s not over until it is over, and that is surely not right now,” he said during a Nov. 8 panel discussion at the International Monetary Fund in Washington.
Summers, who dropped out of the race to succeed Bernanke in September, said “there is really no evidence” that growth is returning to previous levels.
Bernanke, who appeared on the same panel, called the comments “fascinating.”