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.



Simple Math: ½% + ½% = 1%

Recoveries have been weakening due to declines in growth in output per hour (i.e., productivity), growth in hours worked, or both. Taken together, they add up to real GDP growth. It’s just simple math.

For the past four years, productivity growth (green line) has averaged just over ½% per year (red line), leading Fed Vice Chairman Stanley Fischer to lament that it “has stayed way, way down.” Given the latest data, one could say that the U.S. is in a “productivity recession,” having seen the largest back-to-back quarterly productivity declines in 22 years.

It’s often assumed that productivity growth will rebound to its post-World War II average – around 2¼% per year (gold line). But you know what they say about assumptions. To quote Fischer again, “productivity is extremely difficult to predict,” and “will perhaps eventually return” to its earlier pace. In other words, there’s no clear reason why that will happen anytime soon. Indeed, since the end of 2013, productivity growth has averaged minus 0.7% a year.

Potential labor force growth (blue line) should reflect the long-term trend in growth in hours worked. But the Congressional Budget Office says it will stay at ½% per year at least for the next decade. This is pretty much set in stone, given the demographics.

Adding up the likely trend growth of these two measures – ½% for productivity plus ½% for hours worked – gives us just 1% longer-term real GDP growth.

So, unless there’s good reason to believe that productivity growth will revive, trend GDP growth may very well stay stuck in the 1% range for years to come. If so, growth slowdowns could much more easily push growth below zero, leaving very little room for error. Is the Fed ready?

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