The economy has been on a roller coaster in the last six months. Gross domestic product contracted by 2.9 percent in the first-quarter (due in part to crippling weather), a massive gut-floating plunge, but by June the economy started showing signs of recovery. Manufacturing output, generally indicative of overall economy activity, has increased consistently and the headline unemployment rate fell to 6.1 percent in June.
There’s more to the picture than just euphoria over a falling unemployment rate. Claims for unemployment insurance are down, consumer spending is generally (though modestly) improving, and exports are up. But on the other hand, long-term unemployment is still pervasive and there are very real concerns about financial stability as quantitative easing heads to a close.
With a set of such mixed data, it is difficult to accurately predict anything about the growth trajectory of the economy in the coming months. Many growth estimates for economic growth in the coming quarters have been modest, and most were revised lower when the final first-quarter GDP growth estimate came in so low.
But this difficulty did not dissuade Jeffrey Lacker, president of the Federal Reserve Bank of Richmond. On Tuesday, Lacker gave an update on the economic situation as he sees it.
“Since the end of the recession, real GDP has grown at an average annual rate of just 2.1 percent. In contrast, in the 60 years before the recession, real GDP grew at an average annual rate of 3.5 percent,” Lacker explained. “Based in part on that long track record, many forecasters, myself included, were expecting growth to pick up to a more robust pace. More recently, however, I have come to the conclusion that a sustained acceleration of growth to something over 3 percent in the near future is unlikely. Given what we know, it strikes me as more likely that growth will continue to average somewhere between 2 and 2 1/2 percent.”
This low growth is due to structural problems that we have lost sight of while discussing the isolated monthly headline numbers in the news media. The first such problem that Lacker mentions is lower productivity growth, or lower GDP per employee. GDP is the total value of goods and services produced in a country.
An increase in output per employee indicates how real wages and real household income would grow. Real household income determines growth in consumer spending that feeds economic activity. The rate of productivity growth has slipped from an annual rate of 1.4 between 1969 and 2007 to 1 percent since the fourth-quarter of 2007.
Another important component of economic growth is the rate of employment. The rate of growth in employment has been about two-thirds of the rate U.S. saw in the decades prior to the Great Recession, according to Lacker.
One reason for this decline is emphasized by the decline in the labor force participation rate. Labor force participation includes the pool of workers who either have a job or are actively seeking one. This rate has declined from 66 percent in 2007 to 62.8 percent in June this year, lowest since the mid-’70s, according to Bureau of Labor Statistics data. The drop in labor force participation is symptomatic of a few other changes like slower growth in working age population, people going back to schools for lack of job opportunities, and baby boomers retiring en masse. According to data provided by Federal Reserve Bank of Cleveland, since 2000 the participation rate for people ages 16 to 24 dropped from 66 percent to about 55 percent.
The number of Americans born between 1946 and 1964 — the generation of baby boomers who fuelled economic activity, spending and employment in the early ’80s and ’90s — are retiring in large numbers and their presence in the labor force is shrinking fast. In 2003, 82 percent of boomers were part of the labor force; a decade later, that number has declined to 66 percent, and it will naturally continue to fall.
Lastly, consumer spending has not picked up enough to support a stable economic growth just yet. “U.S. consumers seem to remain chastened by the memory of unexpectedly dramatic losses in income and wealth experienced during the Great Recession, and they’ve been cautious about expanding spending as a result,” Lacker said. “So it’s hard to see a significant acceleration in consumer spending on the horizon.”
Unless productivity per unit of labor is improved and structural problems in the labor markets are addressed, it is unlikely that monetary stimulus by the Federal Reserve alone will be able to achieve much in speeding up economic growth and such a stimulus would always carry the underlying risk of fueling inflation.