Is U.S. Growth Really Strengthening?

March 28, 2018

Although the first derivative of the U.S. economy’s size has been very consistently positive, the answer to the above question is more debatable. In the nearly nine years since the Great Recession ended in mid-2009, real GDP rose in 35 of 36 quarters through end-2017, and the exception was a mere 0.9% annualized on-quarter dip in the winter of 2014. But whether growth is in fact faster pertains to the second derivative.

Real GDP growth last quarter was today revised upward to 2.9% at a seasonally adjusted annualized rate (SAAR) from 2.5%. Growth averaged 3.0% during the last three quarters of 2017, making it indeed seems that the U.S. is achieving faster speed. However, average growth in 2017 was still just 2.3%, which though better than calendar year growth in 2011, 2012, 2013, and 2016 was less than achieved in 2010, 2014, and 2015. If one looks at the last eight calendar years as four consecutive pairs, one finds a very steady progression of economic growth: 2.1% in 2010-11, 2.0% in 2012-13, 2.7% in 2014-15, and 1.9% in 2016-17. Moreover, the weakest pair is the most recent.

Incomplete data for the current first quarter of 2018 suggests a significantly slower advance in real GDP, perhaps even less than 2.0%, than occurred in the final three quarters of 2017. If that in fact is the case, it would fit the see-saw pattern of this whole expansionary cycle, which thus far has not yielded any calendar years with economic growth of 3.0% or more. Since 2001, the only years with growth above that threshold were 3.8% in 2004 and 3.3% in 2005. In contrast, growth surpassed 3.0% in 14 of the 18 prior years and averaged 4.4% per year in the final four of them (1997-2000). That’s why economists started talking about a “new and slower normal,” and a breakout above that new normal really isn’t supported by the data.

The composition of U.S. growth in the fourth quarter of last year wasn’t as balanced as one might hope. Personal consumption, which represents about 70% of GDP, accounted for 95% of all growth. Net exports and inventories exerted a combined drag of 2.5 percentage points on the GDP growth rate. Government expenditures, which had risen fourth quarter-over-fourth quarter by only 0.5% in 2014, 1.6% in 2015, 0.4% in 2016 and 0.7% in 2017, climbed 3.0% at an annualized rate in the final quarter of last year, and that was faster by far than in any quarter of the last four years. By doing so, public spending enhanced the last quarter’s GDP growth rate by half a percentage point. We’ll have to see if that is sustainable.

An assessment that the U.S. economy has strengthened is a critical pillar upon which Fed rate normalization rests. GDP continues to expand, but its growth hasn’t convincingly accelerated. If growth has become more inflation-prone, one needs to assert additionally that the economy has a significantly lower speed limit, and the weakness of investment spending and labor productivity suggest that such is so. It’s harder to tell how imminent an inflationary breakout might be. Throughout this economic upswing, analysts have chronically thought the inflection point was closer than it already has proven to be. The very low unemployment rate seems to corroborate that monetary policymakers would be wise to be more vigilant in guarding against future inflation. But suggesting otherwise, the labor participation rate of 63.0% last month remained historically low. Such slightly exceeded 66% in 2008 when the Great Recession began and was at 67.3% at the start of the 21st century. Similarly, average hourly earnings growth of 2.6% on year is still tepid.

The most compelling reason for Fed rate normalization is a factor that isn’t being hid by monetary officials, but it’s not the justification that’s been stressed the most, either. Eventually, there is going to be a downturn, maybe not this year, but analysts attach respectable odds to a setback in one of the following two years. The Fed needs to have interest rate tools as well as quantitative stimulus options when that recession strikes. If officials can nudge their interest rate higher gradually without undermining the economy, it makes sense to seize the opportunity.

Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

 

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