As U.S. expansion notches record, recovery may have only just begun
WASHINGTON (Reuters) – A now record-setting run of U.S. economic growth enters its 121st month on Monday, sustained by a decade of low interest rates and massive Federal Reserve intervention that helped put 22 million people back to work.
But the real economic recovery may only be in its infancy, and, if recent history is any guide, it could be approaching a delicate moment.
It was only last year that U.S. gross domestic product caught up with estimates of its potential, surpassing where Congressional Budget Office analysts feel it would have been if the housing bubble hadn’t burst in 2007, investment bank Lehman Brothers hadn’t failed the following year, and the world had not cratered into a deep recession.
The periods when GDP exceeds potential are typically when workers enjoy the greatest wage gains and members of historically sidelined communities find jobs. In recent years, those periods have not lasted long, a fact that Fed and other officials are wrestling with as they weigh possible interest rate cuts and assess just where the U.S. economy now stands.
“We’re only now making up ground,” even though the economy has been growing since June 2009, the month the National Bureau of Economic Research marked as the “trough” of the last recession, said Vincent Reinhart, chief economist at Mellon.
The approach of the decade-long expansion mark has boosted speculation about how much longer the recovery might last, whether a recession is inevitable in the next couple of years, and whether the Fed and U.S. government are adequately prepared to fight another downturn.
For the type of progress Fed and elected officials feel is needed to rebuild middle-class incomes, it may take several more years.
The 2007-2009 recession wiped $600 billion dollars from U.S. GDP on an inflation-adjusted basis. It created an even bigger gap, of close to $1 trillion, between U.S. output and the economy’s potential based on its population, industrial base, and other factors, according to estimates created annually by the CBO.
Those estimates, dating back to the years just after World War Two, show a pattern that labor advocates argue should make the U.S. central bank willing to take some risks on behalf of wage earners.
For most of the time since 1949 – 178 of 281 quarters as measured by the CBO – the economy has been below potential.
Yet it is only during sustained periods when it operates above potential that workers claw back a higher share of the country’s economic output.
That happened consistently in the decade or two immediately following World War Two, and most notably in the late 1960s when a six-year run of output above potential helped push the share of GDP taken home by workers to close to 65%.
The only recent comparable era was the late 1990s, when GDP stayed above potential for nearly five years and labor’s share of national output, which had dipped below 60% at that point, again rebounded.
Those two eras ended differently. One gave way to a period of excessive inflation that led the Fed to impose record-high interest rates that triggered a recession, beginning an era when output took 15 years to crawl back to potential.
The other was nursed along by a Fed that trimmed interest rates at a time and in a way to keep growth on track, and ended with only a mild downturn in 2000.
The central bank, which signaled in mid-June that it could cut interest rates as early as this month, is trying to make a similar read now in hopes of sustaining the sort of “tight” economy over the several more years needed for workers to gain more ground.
But the environment has changed.
In the short-term, global trade disputes and other risks could slow the economy no matter what the Fed does.
The risk of inflation may be low, but so is the expected trend rate of growth in an economy where people are aging and productivity is lagging – a drag on workers’ potential to recover.
Income and wealth inequality, and the effects of automation on the workforce, have become an increasing concern, but so has the risk that keeping interest rates too low might feed the sort of excessive debt that caused the last financial crisis.
The U.S. economy has only operated above potential in 12 quarters since 2001, including the last four. Labor’s share of national output at the start of this year was just over 56%, in dollar terms about $1.5 trillion short of what it would be at the peak levels in the 1960s and 1990s.
The expansion may have notched its record, but it may take a bit of nerve for the Fed to extend a recovery that, in many ways, is only just starting.
“It feels like a new world with structurally less global demand and structurally less resilience in our economies,” said Nathan Sheets, chief economist at PGIM Fixed Income. “That is the nature of the new world that we are in. It does make it more complicated.”
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