Fed’s Dismal Long-Term GDP Outlook; Economy Remains Unaware, Says Reuters

By Howard Schneider

WASHINGTON – The Federal Reserve faced a critical moment during its policy meeting in September 2016, as it grappled with the unexpectedly slow recovery of the U.S. economy following the recession of 2007-2009. At that time, John Williams, who is now the president of the New York Fed, but was then leading the San Francisco Fed, noted that due to factors like stagnant productivity and an aging population, achieving a sustained annual growth rate of 2.5% or more was deemed "not possible anymore." Consequently, the Fed reduced its long-term GDP growth outlook to 1.8%, marking a significant downward adjustment that had taken place over the preceding decade.

Contrary to this outlook, the U.S. economy has outpaced the anticipated growth rate in 21 of the 28 quarters since that meeting, including a period of 2.5% annual growth from 2016 up until the onset of the pandemic. Under President Joe Biden, growth has averaged around 3%. However, the pandemic’s impact, with major disruptions to growth in 2020 and subsequent government spending, complicates the analysis of current economic trends.

As policymakers congregate for their annual research symposium in Jackson Hole, Wyoming, where discussions will center around "structural shifts," they will need to confront an economy undergoing significant changes. This includes better-than-expected growth in the U.S. labor force, a surge in manufacturing construction, shifting global supply chains, persistent inflation, and potential improvements in productivity.

Despite these developments, it remains unlikely that experts will revise their cautious estimates of the economy’s potential. Slower population growth is a structural element of the U.S. economic forecast, and immigration continues to be a contentious topic. Furthermore, improvements in productivity—the other critical growth driver—are difficult to predict.

Economists at investment firm BlackRock recently expressed even more pessimistic views, forecasting potential U.S. growth rates as low as 1% due to factors such as the retirement of the baby boomer generation, erratic inflation, and ongoing worker shortages.

Over the last several years, decision-makers have been frequently caught off guard, prompting a broader discussion within circles that analyze economic conditions. For example, from September 2016 to 2019, U.S. labor force growth was about twice the anticipated rate, demonstrating that workforce participation was more resilient than previous forecasts suggested.

To benefit the economy, however, the available workforce must find opportunities for employment. Since 2016, policies from the vastly different administrations of Donald Trump and Joe Biden have inadvertently complemented one another, leading to job and economic growth that consistently exceeds the Fed’s estimates.

Under Trump, corporate tax cuts and regulatory changes propelled growth in ways that surprised Federal Reserve officials. In turn, Biden’s policies—including investments in energy and technology along with significant infrastructure spending—have stimulated manufacturing construction. Additionally, both administrations have introduced recovery measures following the pandemic, which may still be supporting consumer and local government spending.

The unemployment rate reached 3.5% in February 2020, and it has remained nearly at that level since March 2022 under Biden, with the economy adding approximately 200,000 jobs monthly.

However, this growth is deemed unsustainable by some economists, including Dana Peterson from the Conference Board, who noted that government-driven growth does not yet reflect any fundamental shifts in performance. She highlighted two significant challenges: increasing public debt and the Federal Reserve’s inflation-fighting measures.

The Fed has raised interest rates by 5.25 percentage points since March 2022 in an effort to control inflation, yet the economy continues to show resilience, growing at a 2.4% annual rate in the second quarter and potentially maintaining strength in the third quarter. Many economists anticipate a slowdown, but as long as growth remains robust, the Fed may need to apply further pressure.

Fed projections for potential U.S. economic growth have declined from around 2.5% a decade ago to 1.8% as of June 2023. According to Peterson, a recession is probable within the next year, driven by the Fed’s policies, followed by a period of slower growth.

A different perspective corresponds to former Fed Chair Alan Greenspan’s mid-1990s view that rapid growth was linked to technological advancements enabling greater productivity without fueling inflation. During the early stages of the pandemic, some economists speculated that new technology applications and remote work could enhance worker efficiency.

Last year, Fed economists argued that despite the pandemic restructuring certain industry trends, productivity growth remained at about 1.1% annually. However, a significant jump in productivity, with a 3.7% annualized rate in the second quarter, raises hopes of a potential upward shift in productivity trends.

Yet, with inflation still a pressing issue, this productivity growth may have limited implications for the Fed’s policy. Nonetheless, sustained economic growth amid declining prices could help support the Fed’s objectives and suggest rising long-term potential.

As noted by Antulio Bomfim, a former senior adviser at the Fed, while it is challenging to draw direct conclusions from recent growth trends, the prevailing risks appear to lean favorably towards future economic performance.