The Crux of the Fed Tapering Debate Boils Down to the Likely Future Growth Rate

June 25, 2013

The long-term growth rate of U.S. real GDP has been decelerating.  Real GDP expanded at a 4.0% annualized growth rate over the 25 years to the fourth quarter of 1974 and 3.3% per annum over the ensuing quarter century to 4Q99.  Since end-1999, GDP has climbed at a 1.7% annualized rate including 1.8% over the past four reported quarters.

New projections released by the Fed last week consider the long-term trend to be 2.4%, about 33% above the pace of the past 13 years, and anticipate above-trend growth centered on 3.25% to be likely in both 2014 and 2015.  From such assumptions, an urgency to reduce quantitative easing sooner rather than later emerges. 

I’m less optimistic about prospects for growth in the coming few years than the Fed, and my view is shared by many private economists.  For us, it appears unlikely that the Fed will get sustained support for cutting back stimulus, although it is possible that it might be later than summer that Fed officials realize that the economic expansion is as self-sustaining as they presume.

The Fed’s mandate is expressed in terms of inflation and jobs, not GDP growth per se.  In the 1980s and 1990s, U.S. jobs rose 84.5% and 67.3% as much as the U.S. population, but in the decade of the 20-naughties, jobs fell by 1.957 million, while the population climbed 27.3 million.  That enormous hole in the labor market is not getting deeper, but neither has it been filled in.  Jobs growth of 5.9 million since April 2010 equaled 80.4% of the increase in U.S. population.  A loose labor market explains why wage inflation remains so low. 

Inflation is below the Fed’s desired level and well below its historic trend.  Consumer prices rose 1.4% over the last 12 reported months, and core CPI inflation stands at 1.7%.  Those rates compare to long-term total and average CPI inflation of 2.8% and 2.6% over the previous 25 years (a period that does not overlap with the extreme spike in the 1970s and early 1980s.

There will be days like today, nonetheless, when the Fed’s assumptions may look plausible.  Today’s U.S. releases highlighted

  • Strong orders for durable goods, which increased 3.6% on month but just 7.7% on year.  Other indications of investment haven’t been so buoyant.
  • Surprisingly rapid house price inflation.  The Case Shiller-20 index jumped 2.5% on month in April and has risen at least 1.0% each month this year.  On-year house price inflation is at 12.1% according to the CS-20 measure and 7.4% according to the FHFA index.
  • Improved consumer confidence, which according to the Conference Board index jumped 7.1 points to a reading of 81.4 in June versus 61.9 in March.
  • The continuing recovery of demand for new homes.  New home sales rose 2.1% last month and were 29% greater than in May 2012.  This demand fuels housing starts and thus directly support real GDP and construction jobs.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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