Digital Finance Analytics (DFA) Blog
"Intelligent Insight"
The latest data from the US Federal Reserve shows that consumer credit increased at a seasonally adjusted annual rate of 7 percent during the third quarter. Revolving credit increased at an annual rate of 5-1/4 percent, while nonrevolving credit increased at an annual rate of 7-1/2 percent. In September, consumer credit increased at an annual rate of 6-1/4 percent.
Further evidence supporting a rate rise in December?
Fed Vice Chairman Stanley Fischer spoke at the 17th Jacques Polak Annual Research Conference, sponsored by the International Monetary Fund, Washington, D.C. He discussed the US Economic Outlook, and labor market conditions and said the markets put a probability of above 70 percent on the rate being increased in December.
With today’s data in the news, I will first say a few words about labor market conditions before moving on to discuss the economic outlook and monetary policy.
The labor market has, by and large, had a pretty good year. Including this morning’s release for October, payrolls have increased an average of 181,000 per month this year, a slower pace than last year but enough to keep the unemployment rate flat at about 5 percent. The unchanged unemployment rate reflects a positive, though perhaps transitory, development–mainly a pickup in labor force participation. The rise in participation may reflect the effects of the modest pickup in wages we are now seeing, with the rate of increase in the employment cost index having risen from an annual rate of about 2 percent last year to 2-1/4 percent so far this year.
Over the course of the past two years, a variety of negative shocks have affected the U.S. economy, but employment has resumed robust growth after each temporary slowdown: This recovery has been and continues to be powerful in terms of one of our two main targets–employment–and it is my view that the labor market is close to full employment.
It is nonetheless interesting to ask what level of payroll gains would maintain an unemployment rate of roughly 5 percent. Unsurprisingly, the level of payroll gains consistent with an unchanged unemployment rate is highly dependent on developments in labor force participation. If labor force participation was to remain flat, job gains in the range of 125,000 to 175,000 would likely be needed to prevent unemployment from creeping up. However, if labor force participation was to decline, as might be expected given demographic trends, the neutral rate of payroll gains would be lower. If we assumed a downward trend in participation of about 0.3 percentage point per year, in line with estimates of the likely drag from demographics, job gains in the range of 65,000 to 115,000 would likely be sufficient to maintain full employment.
Last week we received some encouraging news on output growth. After a slow first half, real gross domestic product (GDP) increased almost 3 percent in the third quarter. However, the details were a little less exciting than the headline number. Household spending growth slowed, and residential investment declined. Business investment in equipment fell for the fourth consecutive quarter. A surge in exports supported growth; however, much of the increase was in shipments of soybeans, while exports of other goods remained tepid. Growth was also supported by a buildup in inventories, breaking a streak of five quarters in which inventories contributed negatively to growth, the longest such run in more than 50 years. Overall, I expect GDP growth to continue at a moderate pace, supported by household spending, renewed business investment, and the waning effects of past dollar appreciation on export growth.
I will now turn to inflation. Headline PCE (personal consumption expenditures) inflation has moved up this year, with the 12-month change reaching 1.2 percent in September. As the transitory effects of the earlier fall in oil prices and rise in the dollar fade, PCE inflation can be expected to rise further toward our 2 percent target, supported by higher core PCE inflation, which ran at a 1.7 percent pace in September.
As you know, earlier this week, we decided to keep the target range for the federal funds rate at 1/4 to 1/2 percent. As was noted in the Federal Open Market Committee’s statement, our assessment is that the most recent data have further strengthened the case for increasing the target range for the federal funds rate. The markets put a probability of above 70 percent on the rate being increased in December.
So far I’ve been discussing our near-term economic prospects. But the more interesting and important questions relate to the next few years rather than the next few months. They relate in large part to the secular stagnation arguments that were laid out yesterday in Larry Summers’ Mundell-Fleming lecture–in particular the behavior of the rate of productivity growth. The statement that the problem we face is largely one of demand–and we do face that problem–seems to imply either that productivity growth is called forth by aggregate demand, or a Say’s Law of productivity growth, namely that productivity growth produces its own demand.
That is not an issue that can be answered purely by theorizing. Rather, it will be answered by the behavior of output and inflation as we approach and perhaps to some extent exceed our employment and inflation targets.
Real gross domestic product (GDP) growth in the U.S. has been relatively slow since the recession ended in June 2009. It has averaged about 2 percent over the past seven years, compared with roughly 3 percent to 4 percent in the three previous expansions. At this point, the slower growth during the current recovery can no longer be attributed to cyclical factors that resulted from the recession—rather, it likely reflects a trend.
source: tradingeconomics.com
A common topic of discussion among observers of the U.S. economy is how to return to a higher growth rate for the U.S. economy. The pace of growth is important because it has implications for the nation’s standard of living. For instance, at an annual growth rate of 1 percent, a country’s standard of living would double roughly every 70 years; at 2 percent it would double every 35 years; at 7 percent it would double every 10 years.
While some might want to turn to monetary policy as the tool for increasing the GDP growth trend, monetary policy cannot permanently alter the long-run growth rate. Leading theories say that monetary policy can have only temporary effects on economic growth and that, ultimately, it would have no effect on economic growth because money is neutral in the medium term and the long term. Monetary policy can only pull some growth forward (e.g., when the economy is in recession) in exchange for less growth in the future. This process allows for a smoother growth rate across time—so-called “stabilization policy”—but there would be no additional output produced overall.
One of the most important drivers of increased real GDP growth in the long run is growth in productivity. In recent years, average labor productivity growth in the U.S. has been very slow. For the total economy, it grew only 0.4 percent on average from the second quarter of 2013 to the first quarter of 2016, whereas it grew 2.3 percent on average from the first quarter of 1995 to the fourth quarter of 2005.
What influences productivity over time? The literature on the fundamentals of economic growth tends to focus on three factors. One is the pace of technological development. Productivity improves as new general purpose technologies are introduced and diffuse through the whole economy. Classic examples are the automobile and electricity. The second factor is human capital. The workforce receives better training and a higher level of knowledge over time, both of which help make workers more productive and improve growth over the medium and long run. The third factor is productive public capital. The idea is that government would provide certain types of public capital that would not otherwise be provided by the private sector, such as roads, bridges and airports. This type of public capital can improve private-sector productivity and, therefore, may lead to faster growth.
The U.S. experienced faster productivity growth in the not-too-distant past. If we could return to the productivity growth rates experienced in the late 1990s, the U.S. economy would likely see better outcomes overall. As a nation, we need to think about what kinds of public policies are needed to encourage higher productivity growth—and, in turn, higher real GDP growth—over the next five to 10 years. The above considerations suggest the following might help: encouraging investment in new technologies, improving the diffusion of technology, investing in human capital so that workers’ skillsets match what the economy needs, and investing in public capital that has productive uses for the private sector. These are all beyond the scope of monetary policy.
Low interest rates have a profound impact on economies, and households. It is important to understand what is driving the ultra-low rates, and the implications for future growth. The Fed’s Vice Chairman Stanley Fischer says lower growth, demographic changes, weak investment and global developments all are responsible for driving rates lower for longer.
However, we think there is a missing link. The factors discussed are driving incomes lower for many, making the prospect of debt repayment just a distant dream. Excessive debt was not discussed. It should be.
There are at least three reasons why we should be concerned about such low interest rates. First, and most worrying, is the possibility that low long-term interest rates are a signal that the economy’s long-run growth prospects are dim. Later, I will go into more detail on the link between economic growth and interest rates. One theme that will emerge is that depressed long-term growth prospects put sustained downward pressure on interest rates. To the extent that low long-term interest rates tell us that the outlook for economic growth is poor, all of us should be very concerned, for–as we all know–economic growth lies at the heart of our nation’s, and the world’s, future prosperity.
A second concern is that low interest rates make the economy more vulnerable to adverse shocks that can put it in a recession. That is the problem of what used to be called the zero lower bound on interest rates. In light of several countries currently operating with negative interest rates, we now refer not to the zero lower bound, but to the effective lower bound, a number that is close to zero but negative. Operating close to the effective lower bound limits the room for central banks to combat recessions using their conventional interest rate tool–that is, by cutting the policy interest rate. And while unconventional monetary policies–such as asset purchases, balance sheet policies, and forward guidance–can provide additional accommodation, it is reasonable to think these alternatives are not perfect substitutes for conventional policy. The limitation on monetary policy imposed by low trend interest rates could therefore lead to longer and deeper recessions when the economy is hit by negative shocks.
And the third concern is that low interest rates may also threaten financial stability as some investors reach for yield and compressed net interest margins make it harder for some financial institutions to build up capital buffers. I should say that while this is a reason for concern and bears continual monitoring, the evidence so far does not suggest a heightened threat of financial instability in the post-financial-crisis United States stemming from ultralow interest rates. However, I note that a year ago the Fed did issue warnings–successful warnings–about the dangers of excessive leveraged lending, and concerns about financial stability are clearly on the minds of some members of the Federal Open Market Committee, FOMC.
Those are three powerful reasons to prefer interest rates that are higher than current rates. But, of course, Fed interest rates are kept very low at the moment because of the need to maintain aggregate demand at levels that will support the attainment of our dual policy goals of maximum sustainable employment and price stability, defined as the rate of inflation in the price level of personal consumption expenditures (or PCE) being at our target level of 2 percent.
That the actual federal funds rate has to be so low for the Fed to meet its objectives suggests that the equilibrium interest rate–that is, the federal funds rate that will prevail in the longer run, once cyclical and other transitory factors have played out–has fallen. Let me turn now to my main focus, namely an assessment of why the equilibrium interest rate is so low.
To frame this discussion, it is useful to think about the real interest rate as the price that equilibrates the economy’s supply of saving with the economy’s demand for investment. To explain why interest rates are low, we look for factors that are boosting saving, depressing investment, or both. For those of you lucky enough to remember the economics you learned many years ago, we are looking at a point that is on the IS curve–the investment-equals-saving curve. And because we are considering the long-run equilibrium interest rate, we are looking at the interest rate that equilibrates investment and saving when the economy is at full employment, as it is assumed to be in the long run.
I will look at four major forces that have affected the balance between saving and investment in recent years and then consider some that may be amenable to the influence of economic policy.
The economy’s growth prospects must be at the top of the list. Among the factors affecting economic growth, gains in productivity and growth of the labor force are particularly important. Second, an increase in the average age of the population is likely pushing up household saving in the U.S. economy. Third, investment has been weak in recent years, especially given the low levels of interest rates. Fourth and finally, developments abroad, notably a slowing in the trend pace of foreign economic growth, may be affecting U.S. interest rates.
To assess the empirical importance of these factors in explaining low long-run equilibrium interest rates, I will rely heavily on simulations that the Board of Governors’ staff have run with one of our main econometric models, the FRB/US model. This model, which is used extensively in policy analyses at the Fed, has many advantages, including its firm empirical grounding, and the fact that it is detailed enough to make it possible to consider a wide range of factors within its structure.
Going through the four major forces I just mentioned, I will look first at the effect that slower trend economic growth, both on account of the decline in productivity growth as well as lower labor force growth, may be having on interest rates. Starting with productivity, gains in labor productivity have been meager in recent years. One broad measure of business-sector productivity has risen only 1-1/4 percent per year over the past 10 years in the United States and only 1/2 percent, on average, over the past 5 years. By contrast, over the 30 years from 1976 to 2005, productivity rose a bit more than 2 percent per year. Although the jury is still out on what is behind the latest slowdown in productivity gains, prominent scholars such as Robert Gordon and John Fernald suggest that smaller increases in productivity are the result of a slowdown in innovation that is likely to persist for some time.
Lower long-run trend productivity growth, and thus lower trend output growth, affects the balance between saving and investment through a variety of channels. A slower pace of innovation means that there will be fewer profitable opportunities in which to invest, which will tend to push down investment demand. Lower productivity growth also reduces the future income prospects of households, lowering their consumption spending today and boosting their demand for savings. Thus, slower productivity growth implies both lower investment and higher savings, both of which tend to push down interest rates.
In addition to a slower pace of innovation, it is also likely that demographic changes will weigh on U.S. economic growth in the years ahead, as they have in the recent past. In particular, a rising fraction of the population is entering retirement. According to some estimates, the effects of this population aging will trim about 1/4 percentage point from labor force growth in coming years.
Lower trend increases in productivity and slower labor force growth imply lower overall economic growth in the years ahead. This view is consistent with the most recent Summary of Economic Projections of the FOMC, in which the median value for the rate of growth in real gross domestic product (GDP) in the longer run is just 1-3/4 percent, compared with an average growth rate from 1990 to 2005 of around 3 percent.
We can use simulations of the FRB/US model to infer the consequences of such a slowdown in longer-run GDP growth for the equilibrium federal funds rate. Those simulations suggest that the slowdown to the 1-3/4 percent pace anticipated in the Summary of Economic Projections would eventually trim about 120 basis points from the longer-run equilibrium federal funds rate.
Let me move now to the second major development on my list. In addition to its effects on labor force growth, the aging of the population is likely to boost aggregate household saving. This increase is because the ranks of those approaching retirement in the United States (and in other advanced economies) are growing, and that group typically has above-average saving rates.9 One recent study by Federal Reserve economists suggests that population aging–through its effects on saving–could be pushing down the longer-run equilibrium federal funds rate relative to its level in the 1980s by as much as 75 basis points.
In addition to slower growth and demographic changes, a third factor that may be pushing down interest rates in the United States is weak investment. Analysis with the FRB/US model suggests that, given how low interest rates have been in recent years, investment should have been considerably higher in the past couple of years. According to the model, this shortfall in investment has depressed the long-run equilibrium federal funds rate by about 60 basis points.
Investment may be low for a number of reasons. One is that greater perceived uncertainty could also make firms more hesitant to invest. Another possibility is that the economy is simply less capital intensive than it was in earlier decades.
Fourth on my list are developments abroad: Many of the factors depressing U.S. interest rates have also been working to lower foreign interest rates. To take just one example, many advanced foreign economies face a slowdown in longer-term growth prospects that is similar to that in the United States, with similar implications for equilibrium interest rates in the longer run. In the FRB/US model, lower interest rates abroad put upward pressure on the foreign exchange value of the dollar and thus lower net exports. FRB/US simulations suggest that a reduction in the equilibrium federal funds rate of about 30 basis points would be required to offset the effects in the United States of a reduction in foreign growth prospects similar to what we have seen in the United States.
From the St. Louis Fed On The Economy Blog.
Two measures commonly used to gauge the country’s economic activity have started to move in opposite directions, according to an Economic Synopses essay.
Economist Ana Maria Santacreu examined these two measures:
- The capacity utilization rate, which is the percentage of resources used by corporations and factories to produce finished goods
- The fraction of the labor force currently employed, which is measured as 100 percent minus the unemployment rate
Santacreu noted that companies typically use around 80 percent of their available productive capacity (measured by the capacity utilization rate). This number is higher during economic expansions and lower during recessions. She noted: “Indeed, during the most recent recession, U.S. capacity utilization dropped below 67 percent, the lowest point since the late 1960s.”
The figure below plots the two measures at quarterly intervals from 1967 through the first quarter of 2016.
As the figure shows, employment as a fraction of the labor force tends to move in a similar fashion to the capacity utilization rate. Santacreu noted that the correlation between the two measures was 0.90 for the period 1967:Q1 through 1990:Q1.
However, the correlation became less pronounced during the early 1990s economic crisis and the early 2000s dot-com bubble. Santacreu wrote: “During both episodes, capacity utilization dropped before employment did and began recovering earlier. That is, industrial activity was booming while employment was still low. This phenomenon is known as a jobless recovery.”
Following the Great Recession, these two measures didn’t follow the same pattern as in the previous two recessions. Both measures dropped initially, but employment has been recovering quickly since 2009, while capacity utilization recovered initially but began falling again in 2015.
Why the Divergence?
Santacreu noted that there are several potential reasons why unemployment took longer to recover following the recessions of the early 1990s and early 2000s:
- Firms may have postponed hiring to be sure the recovery was strong.
- Firms may have purchased new equipment instead of hiring additional workers.
- Workers may have had to switch industries, which may have lengthened the time it took to fill positions.
Santacreu wrote: “This is important in comparing capacity utilization and employment as measures of economic activity. Capacity seems to be mainly affected by cyclical factors. Employment, however, is also affected by a structural factor that makes it adjust more slowly than industrial capacity adjusts to recessions and recoveries.”
Regarding the recent divergence, Santacreu noted that two factors may be at play:
- The unemployment rate may have decreased initially because some displaced workers became discouraged and simply dropped out of the labor force.
- More recently, new jobs have been created, bringing the U.S. closer to full employment.
Santacreu concluded: “Capacity utilization and employment tend to comove along the business cycle. However, they may drift apart when labor markets are less flexible or there are structural changes in the economy.”
Fed Vice Chairman Stanley Fischer spoke at the 31st Annual Group of Thirty International Banking Seminar, Washington, D.C. on the U.S. Economy and Monetary Policy.
After running through the current numbers, he turned to the monetary policy outlook. The labor market seems to be the key.
As you know, at our September meeting, the FOMC decided to keep the target range for the federal funds rate at 1/4 to 1/2 percent. As we noted in the statement, the recent pickup in economic growth and continued progress in the labor market have strengthened the case for an increase in the federal funds rate.3 Indeed, in our individual economic projections prepared in advance of the September meeting, nearly all FOMC participants anticipated an increase in the target range for the federal funds rate by the end of this year. Moreover, as economic growth has picked up and some of the earlier concerns about the global outlook have receded, the Committee judged the risks to the U.S. economic outlook to be roughly balanced.
Given that generally positive view of the economic outlook, one might ask, why did we not raise the federal funds rate at our September meeting? Our decision was a close call, and leaving the target range for the federal funds rate unchanged did not reflect a lack of confidence in the economy. Conditions in the labor market are strengthening, and we expect that to continue. And while inflation remains low, we expect it to rise to our 2 percent objective over time. But with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.
As we noted in our statement, we continue to expect that the evolution of the economy will warrant some gradual increases in the federal funds rate over time to achieve and maintain our objectives. That assessment is based on our view that the neutral nominal federal funds rate–that is, the interest rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel–is currently low by historical standards. With the federal funds rate modestly below the neutral rate, the current stance of monetary policy should be viewed as modestly accommodative, which is appropriate to foster further progress toward our objectives. But since monetary policy is only modestly accommodative, there appears little risk of falling behind the curve in the near future, and gradual increases in the federal funds rate will likely be sufficient to get monetary policy to a neutral stance over the next few years.
This view is consistent with the projections of appropriate monetary policy prepared by FOMC participants in connection with our September meeting. The median projection for the federal funds rate rises only gradually to 1.1 percent at the end of next year, 1.9 percent at the end of 2018, and 2.6 percent by the end of 2019. Most participants also marked down their estimate of the longer-run normal federal funds rate, with the median now at 2.9 percent.
However, as we have noted on many previous occasions, policy is not on a preset course. The economic outlook is inherently uncertain, and our assessment of the appropriate path for the federal funds rate will change in response to changes to the economic outlook and associated risks.
A speech by Fed Governor Lael Brainard “Distributed Ledger Technology: Implications for Payments, Clearing, and Settlement” contains a number of interesting use cases, discussed in their blockchain working party.
Let me briefly mention a few of the use cases that we have explored in our discussions with industry stakeholders in order to illustrate the potential of distributed ledger technologies to improve payments, clearing, and settlement, as well as the considerations that are important to us in our assessment of benefits and risks.
In cross-border payments and trade finance, significantly faster processing and reduced costs relative to the long and opaque intermediation chains associated with current methods of correspondent banking are promising potential benefits of the technology. Reducing intermediation steps in cross-border payments may help decrease time, costs, and counterparty risks and may materially diminish opacity, for instance by enabling small businesses or households remitting payments across borders to see the associated transfer costs and processing times up front.
In trade finance, where document-intensive processes are not fully automated, distributed ledger technology may be able to reduce significant costs and speed up processing associated with issuing and tracking letters of credit and associated documents. To see the full potential of this technology realized for cross-border payments, it will be important to identify and track identities associated with the transactions, which in itself may be facilitated by the use of distributed ledgers, depending on their design.
In securities markets, the industry is exploring activities ranging from the issuance of securities on a distributed ledger, to the clearing and settlement of trades, to tracking and administering corporate actions.
For securities clearing and settlement in particular, the potential shift to one master record shared “simultaneously” among users of a distributed ledger-based system could be compelling. Sharing one immutable record may have the potential to reduce or even eliminate the need for the reconciliation of multiple records linked to a single trade among and between dealers and other organizations.
In concept, such technology could lead to greater transparency, reduced costs, and faster settlement. Likewise, distributed ledgers may improve collateral management by improving the tracking of ownership and transactions. Nonetheless, as is frequently true in the complex arena of payments, clearing, and settlement, we can also expect that practical details covering a host of technical, business, and market issues will have an important role in determining how new technologies ultimately perform.
For commodities and derivatives, there are projects to streamline some of the more antiquated corners of the markets. In markets that are heavily paper-based and lack any central means for coordination, distributed ledger technology could potentially be leveraged to provide coordination that facilitates exchange, clearing, and settlement of obligations.
A related development is the potential coupling of distributed ledger protocols with self-execution and possibly self-enforcement of contractual clauses, using so-called “smart contracts.” To take a familiar example, for a corporate bond with a specified par value, tenor, and coupon payment stream, a smart contract would automatically execute payments on the specified schedule to the assigned owner over the life of the bond. Although the idea of automating certain aspects of contracts is not new, and banks do some of this today, the potential introduction of smart contracts does raise several issues for consideration. For example, what is the legal status of a smart contract, which is written in code? Would consumers and businesses rely on smart contracts to perform certain services traditionally done by their banks or other intermediaries? Could the widespread automated interaction of multiple counterparties lead to any unwanted dynamics for financial markets? These and other considerations will be important factors in determining the extent of the application of smart contracts.
Regardless of the application, much of the industry is at a “proof of concept” stage of development. These proofs of concept are often simple, experimental uses of the technology on a small scale that help stakeholders understand the potential and limitations of the technology for a specific purpose, which in turn typically lead to refinements and more developed proofs of concept. As such, many potential applications are in their infancy, and the industry may still be several years away from an application that is ready to be fully implemented. Even so, the industry seems to be making announcements daily on new proofs of concept and progress that may lead to pilots, so that timeline could accelerate. In some cases, there have been announcements the technology will be used within the next year or two in actual production environments. The initial relatively simple proofs of concept must be followed by much more complex demonstrations in real-world situations before these technologies can be safely deployed in today’s highly interconnected, synchronized, and far-reaching financial markets.
Although many private and inward-facing projects are being explored, the industry has also recognized the need to collaborate at early stages of development. An important positive development is that industry participants are actively engaging with each other to look for common approaches. Some groups are creating standards that facilitate common platforms to enable greater interoperability of often proprietary applications that are built on them and interoperate through application program interfaces, or APIs.
In coming months and years, innovators, investors, and financial practitioners will no doubt make important strides in addressing key challenges such as adopting common standards, achieving interoperability between and among legacy systems and evolving distributed ledgers, improving scalability and computational throughput, and improving cryptographic security. These are positive developments that we will monitor closely.
The latest consumer credit data from the federal reserve, including provisional data for August 2016 shows rise to a seasonally adjusted annual rate of 8-1/2 percent. Revolving credit increased at an annual rate of 7 percent, while nonrevolving credit increased at an annual rate of 9 percent.
The data set covers most credit extended to individuals, excluding loans secured by real estate. The percent changes are adjusted to exclude the effect of such breaks. In addition, percent changes are at a simple annual rate and are calculated from unrounded data.
Nonrevolving includes motor vehicle loans and all other loans not included in revolving credit, such as loans for mobile homes, education, boats, trailers, or vacations. These loans may be secured or unsecured.
Here is the longer term trend. Shaded area is the great recession. We see similar growth rates over the past couple of years, highlighting credit growth higher than inflation or income. Further evidence of the growing household debt.
Despite six years of “recovery” from the Great Recession, America’s middle class still struggles financially amid sluggish economic growth and middling job creation.
The Federal Reserve’s near-zero interest rates have helped stabilize the economy after it nearly went into freefall in 2008 and 2009, but that policy is coming to an end, with at least one quarter-point hike expected this year and more in 2017 and 2018.
So what will support the economy once the Fed’s largesse begins to disappear?
I’ve been exploring the key economic data – from productivity and housing to wage growth and consumer spending – to better understand where we’re headed and what is needed to get out of this no-to-low growth environment, a pernicious state some economists call secular stagnation. The data show clearly why serious attention is needed to foster faster growth, a more competitive economy and more opportunities for American families.
And only one institution, I would argue, is able to do something about it: Congress.
Stagnant growth and productivity
For most of the recovery, economic growth has been lackluster.
Gross domestic product has expanded at an average annual inflation-adjusted rate of just 2 percent since the recession ended in the second quarter of 2009, far below the rate of 3.4 percent from December 1948, when the first recession after World War II started, to December 2007, when the most recent recession began. And in just the past three quarters through June, the economy has barely budged, growing at an anemic 1 percent or so.
Productivity growth, measured as the increase in inflation-adjusted output per hour, is key to propelling strong economic growth because it means that workers are getting better at doing more in the same amount of time. Yet productivity rose only a total of 6.6 percent from the second quarter of 2009 to the second quarter of 2016. That amounts to an average rate of 0.9 percent a year, a fraction of the 2.3 percent we experienced from 1948 to 2007.
Housing hasn’t recovered
When considering what’s keeping the recovery from taking off, housing deserves particular attention since it generally boosts economic growth after a recession. Not this time.
Sales of new single-family homes have been on the rise in recent years, but they’re still well below the historical average before the Great Recession, pushing homeownership down to a 50-year low. Sales averaged about 400,000 a year from 2011 to 2015, compared with 698,000 before the recession – from 1963 through 2007.
Although the pace has picked up in recent months – reaching an annual rate of 609,000 in August – it’s still not enough to stop the slide in the homeownership rate, which was 62.9 percent in the second quarter, down from 67.8 percent at the end of 2007.
And spending on housing fell 7.7 percent in the second quarter of 2016, compared with the first three months of the year.
One of the reasons housing has been slow to recover – the market’s collapse was the primary cause of the Great Recession – is that employment growth has remained mostly moderate. Many are still looking for good jobs despite the sharp drop in headline unemployment to an eight-year low of 4.9 percent.
The average annualized employment growth rate from June 2009 to August 2016 was just 1.4 percent, well below the long-run average of 1.9 percent from December 1948 to December 2007.
While there were 13.6 million more jobs in August than in June 2009 – meaning that the economy regained all those lost during and immediately after the recession – these gains and the comparatively low unemployment rate obscure that many people still cannot find the jobs they want. The jobless rate means about 7.8 million individuals were unemployed in August, yet another 7.8 million were either employed part time for economic reasons (they would have preferred a full-time job) or out of work and wanted a job but weren’t counted in the official rate because they hand’t looked in the preceding four weeks.
And communities of color still have higher unemployment rates than whites. The African-American unemployment rate stood at 8.1 percent, while for Hispanics it was 5.6 percent, compared with 4.4 percent for whites.
Wage growth, income inequality and debt
These lackluster job gains have meant there’s less pressure on employers to raise wages. And sluggish wage growth has meant less consumer spending – which typically makes up more than two-thirds of GDP.
Wages, in fact, have barely kept pace with price increases. Inflation-adjusted hourly earnings of production and non-supervisory workers – about 80 percent of the labor force – have increased only about 4.5 percent since June 2009. This amounts to an annualized growth rate of merely 0.6 percent above the rate of inflation over the past seven years.
Low wage growth has kept income inequality at very high levels. A recent report offered some good news: Real median household income grew at 5.2 percent, from US$53,718 in 2014 to $56,516 in 2015 – the fastest annual growth on record dating back to 1968. But inflation-adjusted median income was still higher in 2007 than in 2015.
Middle-class Americans are only slowly gaining ground as wealthier ones had seen bigger gains, leaving income inequality persistently high. In 2015, the top 5 percent of earners captured 22.1 percent of total income, compared with 11.3 percent for the bottom 40 percent. In 1967, those at the top took home 17.2 percent, versus 14.8 percent for the bottom 40 percent.
This lack of wage growth also makes it difficult for households to dig out from under a mountain of debt, which further contributes to limited spending on housing and other items. Household debt equaled 105.2 percent of after-tax income in the second quarter of 2016. While that’s down from a peak of 135 percent in the fourth quarter of 2007, the current level is still much higher than any level of debt observed in the 50 years before 2002.
Moreover, some especially costly forms of credit have grown. Installment debts – mainly student and car loans – have grown from 14.6 percent of after-tax income in June 2009 to 19.2 percent this past June – the highest share since records began in 1968.
Unsurprisingly, consumer spending growth has been middling as a result, increasing an average of just 2.3 percent a year since the end of the Great Recession, far below the long-term average of 3.5 percent from 1948 through 2007.
Companies on the sidelines
With their consumers still mired in debt with little gain in their pocketbooks, businesses have very few reasons to invest.
Net investment – what companies spend on new capital assets rather than on replacing obsolete items – has averaged 1.9 percent of GDP since the recession started at the end of 2007. This is the lowest since World War II.
To be clear, companies have the money. Corporate profits recovered quickly toward the end of the Great Recession and have stayed high since.
So where is all that money going? Cash reserves and shareholders.
Nonfinancial corporations hold an average of 5.2 percent of all of their assets in cash – a high rate by historical standards. At the same time, they spent on average 99 percent of their after-tax profits on dividend payouts and share repurchases to keep their shareholders happy since the start of the Great Recession.
Breathing room
With consumers not spending money because they can’t and businesses not spending money because they don’t want to, the onus falls on Congress to bolster the economy and the labor market.
Yet federal, state and local government spending has been falling. Their total spending on goods and services as a share of GDP was 17.7 percent in the second quarter of 2016, the smallest share since 1998.
Congress, though, now has room to maneuver. The nonpartisan Congressional Budget Office estimated in August that the federal government will have a deficit of 3.2 percent of GDP for fiscal year 2016. This is much smaller than in recent years, including 2009’s deficit of 9.8 percent of GDP – the widest since World War II.
The shrinking deficit, as well as the government’s near-record-low borrowing costs, could provide enough breathing room to focus on targeted, efficient policies that promote long-term economic growth and shared prosperity, for instance, through investments in infrastructure.
The economy and American families need Congress to use this breathing room to create real economic security.
Author: Christian Weller, Professor of Public Policy and Public Affairs, University of Massachusetts Boston
Interesting piece from the St. Louis Federal Reserve On the Economy Blog. House prices fell during the “great recession” in the US by 30% or more. Recent modelling shows that the main reason for the fall was that people’s beliefs about house prices had changed. It was less about a change in the demand for housing or availability of credit. In other words, if enough people think prices will rise, they will rise; but the reverse is also true.
In Australia, we still have more households believing home prices will rise in the next year, as explored in the latest Property Imperative, released yesterday. Thus, if the modelling is correct, this expectation becomes self fufilling.
The causes behind the boom and bust of house prices over the past decade or so are generally boiled down to three possible culprits:
- Fundamental shocks, such as changes in the ability to build houses or in people’s desire to own houses
- Credit market changes, such as looser lending restrictions allowing more people to purchase houses
- Beliefs, or house prices increasing simply because people thought they would increase
Recent research points more strongly to one in particular: that people’s beliefs about house prices had changed.
Greg Kaplan, an economics professor at the University of Chicago, discussed this finding in his paper “Consumption and House Prices in the Great Recession: Model Meets Evidence,” presented at the St. Louis Advances in Research (STLAR) Conference on April 7-8
You can watch a video on this research here. Download a summary of the research here.