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The economy is racing ahead at 2%

Summary:
(I’m not being sarcastic.) Many people (actually almost everyone) have trouble interpreting growth data. There’s a tendency to conflate the normal rate of growth in an expansion with the long run trend rate of growth in RGDP. Actually, the trend rate of growth in RGDP is measured over the entire cycle, including both expansions and recessions. The real growth rate in the US over the past 10 years has averaged slightly above 2%. A few years ago I predicted that it would have slowed to less than 2% by now. I was wrong. Today’s data shows that growth continues right at 2% over the past 12 months. But I was not wrong because productivity has grown faster than I expected; I was wrong because the economy continues to expand at a rate well above its underlying

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(I’m not being sarcastic.)

Many people (actually almost everyone) have trouble interpreting growth data. There’s a tendency to conflate the normal rate of growth in an expansion with the long run trend rate of growth in RGDP. Actually, the trend rate of growth in RGDP is measured over the entire cycle, including both expansions and recessions.

The real growth rate in the US over the past 10 years has averaged slightly above 2%. A few years ago I predicted that it would have slowed to less than 2% by now. I was wrong. Today’s data shows that growth continues right at 2% over the past 12 months.

But I was not wrong because productivity has grown faster than I expected; I was wrong because the economy continues to expand at a rate well above its underlying trend rate of growth. (Here we should cut the Fed a bit of slack, as they made the same sort of error that I made.)

In an accounting sense, the strong 2% growth rate has been produced by slow productivity growth combined with a rising employment-population ratio:

The economy is racing ahead at 2%

You might think that this graph shows that the employment population ratio remains sharply depressed. Not so, adjusting for demographic changes it is near the 2000 peak. As baby boomers retire, you’d expect to see a decline in the ratio, as only about 24% of healthy people over 65 are still working (and even fewer disabled people). The ratio is modestly below peak for ages 25-54, and well above peak for 55-64 and over 65.

Take a look at the employment ratio for the 55-64 age group:

The economy is racing ahead at 2%

Notice that this ratio is now 64.2%, far above the 58% ratio at the peak of the 2000 tech boom. The over 65 ratio is also rising briskly. (Think about all those old codgers working for Uber.)

This is what I got wrong. I thought that growth would slow to 1.5% by now, because I didn’t expect so many old people like me to be working. Indeed, 5 years ago I fully expected to be retired by now—-so I didn’t even correctly forecast my own labor force participation rate at age 64! (Actually, I would be retired if my Mercatus opportunity had not come along.) Old boomers are harder working than previous generations (albeit in much softer jobs.)

Can this surge in labor force participation continue for some time? Yes, I’m duly chastened by my inaccurate forecasts of 5 years ago. But here’s what I do know, the labor force participation rate cannot go above 100%. We’ll need more immigration at some point if we want to maintain 2% RGDP growth—a lot more.

Here’s the most important point I’d like to make. The trend rate of growth is the growth rate that occurs when the age-adjusted employment-population ratio is stable. Because this ratio has recently been rising briskly, even faster than the aggregate data show due to composition effects, we are now growing at well above the economy’s long run trend rate of growth.

That’s right, the recent 2% RGDP growth derided in the media as “weak” is actually very strong, reflective of an unsustainable boom. It might last for several more years, but it’s ultimately unsustainable. The Great Stagnation continues.

PS. I rarely agree with the Germans on monetary policy, but this is an exception:

The head of Germany’s central bank has said he opposes using monetary policy to tackle climate change, setting up a potential clash with Christine Lagarde, who plans to explore the idea after she becomes European Central Bank president on Friday.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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