By John W. Schoen
August 1, 2012
Federal Reserve policymakers wrap up a two-day meeting Wednesday with few options to rev up an economy that may be “stuck in the mud,” as Fed Chairman Ben Bernanke recently told Congress.
“The problem is the things that are holding back the economy – the uncertainty about tax rates next year, the problems in Europe and the problems in Asia — are absolutely nothing that U.S. monetary policy can address with the tools it’s got left,” said John Ryding, chief economist at RDQ economics.
Central bankers are considering more steps, including possibly buying more long-term bonds to keep interest rates low. But those measures are not expected to be announced when the Fed issues a policy statement Wednesday. So for now, it’s wait and hope.
The latest data on gross domestic product highlight the Fed’s long-term quandary. Though growth has slowed sharply from a burst late last year, the expansion continues to chug along at an anemic 1.5 percent annual pace.
That growth avoids the technical definition of recession. But the sluggish pace of hiring makes it feel like a downturn for the 12.7 million American workers still sidelined.
And some experts believe the economy may be permanently stuck in slow-growth mode.
“We do think we’ve seen more permanent changes in the economy as a result of this recession,” said Michelle Meyer, an economist at Bank of America Merrill Lynch. “We estimate potential growth to be at about 2.25 percent, whereas back in in 2005 we were saying it was about 3.5 percent.”
That is a huge downgrade, driven in part by a drop in the number of Americans who have left the workforce — many of them older workers who are gone for good. The pace of growth will be held back as long as an aging baby boom population continues to leave the workforce and cut back on spending.
And of course even people who are working are looking over their shoulder.
“People aren’t necessarily panicked to lose their job, but they’re not really confident enough to borrow a lot and spend a lot,” said Richard Hoey, chief economist of BNY Mellon. “We’re expansionary at a subpar pace. We’re not going into a recession but sure aren’t going into a boom, either.”
It may be while before consumers, who account for 70 percent of U.S. economic activity, begin spending again at levels usually expected in a recovery.
This far into the previous five recoveries, the economy was expanding at an average pace of 4.4 percent, twice the current average. The biggest single missing growth component is consumer spending. The lackluster pace has knocked 1.3 percentage points of growth from the historical pace of recoveries, according to Credit Suisse economist Neal Soss.
Barring a burst of new hiring, consumers aren’t likely to resume spending at historical levels, especially as households continue to work off a surge in credit card and mortgage debt that preceded the financial collapse of 2008. In June, most of the modest increase in personal income went straight into households’ savings, pushing the savings rate to 4.4 percent, the highest level in a year.
Those added savings are further pressuring spending: retail sales have fallen for three months in a row.
“News on the consumer and retail front has gone from bad to worse,” said Chris Christopher, economist at IHS Global Insight.
Some economists argue that the last three years of slow, steady growth, reduce the risk of another “double dip” recession, largely because with so much slack in the economy . Wit and so little excess credit and inventory.
“We’re not going to break down, but we’re not about to accelerate either,” said Hoey. “We’re in a low level expansion. Nobody’s got any excitement. The fear level isn’t too high because of the Fed’s easy policy. So you’re kind of stuck in subpar growth.”
To be sure, the fragile U.S. economy is ill-prepared to sustain another sudden shock like the collapse of the euro or the looming tax increases and spending cuts that will take effect next year if Congress remains deadlocked. But since 1950, there’s little evidence that periods of very slow growth, by themselves, raise the odds of recession, according to Paul Dales, an economist at Capital Economics.
Unlike past business cycles, though, that weak growth pace may last for much longer than any period in recent history. Economists are still debating the causes, but there’s general agreement that the pace of growth has undergone a more or less permanent downshift.
One reason is a slowdown in the productivity of workers still on the job after a string of steady gains. Some of those gains came from business investment in technology and other efficiencies. Some of it came from asking workers — fearful of losing their jobs with the unemployment rate above 8 percent — to work harder and put in longer hours. But employers have apparently wrung about as much as they can from existing employees.
The lingering hangover of the financial collapse has also had a lasting impact on attitudes about saving and borrowing among consumers, businesses and lenders. That has reduced demand for new loans and slowed the pace of business expansion.
All of which means that, no matter how far the Fed drives down interest rates, or how long they keep them there, the central bank faces a daunting task trying to restore growth to pre-recession levels.
If the next decade is marked by an ongoing slowdown in growth, it will continue to feel like a recession for many Americans. Based on growth forecasts of 2.3 percent a year through 2022, the Congressional Budget Office predicts that the unemployment rate will remain above 8.0 percent through 2014 and then gradually fall below 6.0 percent by 2017.
The slow pace of growth is expected to linger for at least a decade.
“If you asked me to forecast what growth will be in 10 years, I’d just put our potential at 2.25 then deviate from that growth based on short-term fluctuations in the economy,” said Meyer.