Secular Growth, Not Stagnation
As the Federal Reserve wraps up its massive bond-buying programs, attention has turned to policymakers’ statements for clues about the timing and speed with which they plan to bring interest rates back to normal levels. But useful insights into the Federal Open Market Committee’s mindset can also be gleaned from its latest economic projections, released just after last week’s meeting. As reflected in the “central tendency” of their forecasts, Federal Reserve Board members and Reserve Bank presidents now place the long-run growth rate of real GDP somewhere between 2.0 percent and 2.3 percent, while the full range of predictions runs from 1.8 percent to 2.6 percent.
To place these numbers in context, the blue line in the figure below plots the historical path of real GDP growth over a period that begins in the first quarter of 1952 and runs through the second quarter of 2014, the last for which data are available. To help isolate the kind of longer-run trends that the FOMC projections aim to capture, the graph shows, for each date, the annualized growth rate of aggregate output extending back over the previous five years. Thus, for example, the 2.2 percent figure for the last date shown corresponds to the annualized rate of real GDP growth over the five-year window beginning in the second quarter of 2009 and running through the second quarter of 2014.
The blue line plots historical real GDP growth over five-year windows, as described above. The red and green lines correspond to the central tendency and full range of FOMC forecasts for future long-term GDP growth.
First and foremost, the graph confirms how severe was the “Great Recession” of 2008-2009 and how anemic has been the ongoing recovery. It is no exaggeration to say that most Americans have never experienced anything nearly as bad as the downturn we have all just lived through. And yet, as the blue line also shows, we have had recessions in the United States before (in the mid-1970s, the early 1980s, and early 1990s) that dragged down growth over sustained periods. Nevertheless, every past recession was followed by an eventual recovery, during which growth rebounded strongly.
Against this historical backdrop, the FOMC’s current projections appear exceedingly pessimistic. In the graph, the horizontal lines show this. The inner, red band identifies the forecasts’ central tendency of 2.0 percent to 2.3 percent, and the outer, green band covers the full range of submitted views. Strikingly, even the most optimistic FOMC member believes that long-run GDP growth, looking forward, will come in at only 2.6 percent. That number stands far below the 3.25 percent rate that is the annual average over the entire historical period. Indeed, looking back before 2007, we see that growth dipped below 2.6 percent over five-year windows only occasionally, in the years shortly following previous recessions. Evidently, FOMC members expect U.S. economic performance to be quite a bit different—and quite a bit worse—than it has ever been in the past.
But is this extraordinary pessimism warranted? To be sure, there is no shortage of worries today. Declining labor force participation, unsustainable retirement and healthcare programs, tax and regulatory policies that penalize productive activity and discourage innovation, and the tendency towards a kind of crony capitalism that favors the least efficient, but politically-connected, enterprises are all valid sources of concern for the future. And yet, looking at the graph, one is also led to wonder if at least some of the prevailing gloom comes from inappropriate extrapolation from the much too recent past. Just as the most optimistic forecasts made after a decade of robust growth in the late 1990s (think “Dow 36000”) turned out to be far overdone, today’s widespread pessimism may one day appear as an overreaction to the very tough times we have experienced more recently.
Along those same lines, too, it helps to remember that the last time that theories of “secular stagnation” enjoyed the popularity that they have today was in the aftermath of the Great Depression. Thanks to the historical work of Milton Friedman and Anna J. Schwartz, we now know that the Depression was caused by a series of tragic policy mistakes, and in no way reflected an inherent instability in our capitalist system. The graph illustrates the golden age of economic growth that followed, in the 1950s and 1960s. More than likely, similar historical investigations, undertaken carefully in the years to come, will conclude that the financial crisis of 2007 and the Great Recession were caused mainly by misguided policies and in no way signal the end of American prosperity.
Perhaps this time will prove different. But long historical experience suggests that for the United States, average growth between 3 percent and 3.25 percent per year will remain the norm. And given the amount of resource underutilization that remains pervasive throughout the economy today, near-term growth rates well above that long-term average remain clear possibilities. Our best days lie ahead, just as they always have.
Peter Ireland is a professor of economics at Boston College and a member of the Shadow Open Market Committee.
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