Is Moderate Growth the New Normal?
Since the end of the recession, the economy has expanded at a slow pace. Recently revised data show that real GDP grew 2.5 percent in the first year of recovery, slowed to a 1.9 percent pace in the second year, and settled to a 2.2 percent growth rate in the third. The economy missed out on the period of rapid recovery that typically follows business cycle troughs, and it has been growing quite steadily at rates lower than in past expansions. We examine the factors behind these subpar growth rates and present some evidence that moderate growth may be the norm going forward.
The current slow pace of expansion is the result of several factors pushing the economy in opposite directions. Factors that are moving the economy forward include high investment growth and stronger household balance sheets. Business fixed investment grew 10.3 percent in the last year, accelerating in the last several quarters. High rates of investment growth were fueled by solid profits and favorable bond finance conditions. Households made substantial progress deleveraging. Households’ ratio of debt to assets declined from a 21.3 percent peak during the recession to the current 17.6 percent, as households reduced their liabilities, while their assets recovered. With stronger balance sheets, households were able to reduce their saving rate from levels above 5 percent to 4 percent, more in line with pre-recession levels, and this lifted one constraint on their spending.
For all of the improvement in business spending and household balance sheets, other factors continue to weigh down the expansion. The labor market remains weak, with slow employment growth and high unemployment, and this constrains household income and spending. The housing sector remains depressed and continues to slow down the recovery, although housing activity and prices suggest that the bottom of the cycle is behind us. Government spending decreased steadily in the last two years, subtracting a total of 1.1 percent from growth. Uncertainty over future fiscal policy and financial market conditions continues to constrain aggregate demand as well.
Looking at productivity and hours worked, we find some evidence that the economy has entered a period of normal expansion at moderate growth rates. If we decompose output into its labor and productivity components, we notice that the recovery has followed a quite standard pattern. Typically, in the initial stages of a recovery, productivity grows strongly, as output picks up while employment and hours lag behind. After that, once productivity has reached a relatively high level, the economy enters a period of normal expansion, where hours and productivity return to normal.
This recovery has followed the same pattern, except that the growth rates of hours and productivity have been lower. In the first year after the recession, productivity grew rapidly, while the labor market remained exceptionally weak. Starting in 2010, however, productivity has progressively slowed down, while hours have picked up and grown in line with previous expansions. This pattern suggests that the economy has completed its initial adjustment period and is currently in a period of normal expansion. If that is true, the current subpar growth rates may be indicative of a trend slowdown. Moderate growth may be here to stay.