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A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

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Cognitive Dissonance at the Fed?


Federal Open Market Committee (FOMC) members have long submitted their projections of U.S. real GDP growth for the “longer run,” to which they expect it “to converge over time – maybe in five or six years – in the absence of further shocks and under appropriate monetary policy.” The chart shows the midpoint of their projections (dark blue line) has dropped to 2.15% – a cut of almost half a percentage point since early 2013 – with at least one estimate as low as 1.8% (not shown).



Separately, the Congressional Budget Office (CBO) publishes the “official” assessment of real potential GDP, defined as its “estimate of the maximum sustainable output of the economy.” Those potential GDP growth estimates for the long term (ten years out) have also been reduced lately (light blue line), primarily due to “demographic trends that have significantly reduced the growth of the labor force.” In just over a year’s time, the CBO has slashed this estimate from just under 2.4% as of January 2013 to only 2.0% as of February 2014.

In other words, official long-term trend GDP growth estimates have been quietly lowered this year to the 2.00% to 2.15% range. Among other reasons, this is notable because it recalls a fast-forgotten 2011 Fed paper suggesting that a reasonable estimate of the U.S. economy’s recessionary “stall speed” was about 2%.

So what is being gradually acknowledged – without any publicity or fanfare – is that long-term U.S. GDP trend growth is converging towards its 2% stall speed. If so, almost every time GDP growth experiences a slowdown that carries it below trend, it will also fall below the recessionary stall speed. This is an implicit endorsement of ECRI’s longstanding “yo-yo years” thesis, which predicts more frequent recessions for the advanced economies than we have seen in past decades.
 
Separately, a recent ECRI report (click to download) demonstrates how the yo-yo years are already a fact.

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