Estimating Real GDP Growth Trends
The economy continues to expand at a slow pace. Real GDP rose at an annual rate of 1.3 percent in the second quarter of 2012, down from 2 percent in the first quarter. The recent subpar growth rates, together with the pattern of productivity and hours worked, suggest that the trend level of real GDP is growing slower than in the past (see “Is Moderate Growth the New Normal?”). Here, we investigate this issue, looking for evidence on the current and long-run growth rates of the real GDP trend.
Learning about trend growth is important for several reasons. Current trend growth helps determine how the gap between actual and trend GDP is evolving over time, which in turn has implications for the outlook of economic growth and inflation. Long-run trend growth is even more important, as it is the rate at which the economy will expand in the long run.
We begin with a simple measure of trend growth that is based on real GDP data only. To construct it, we eliminate all short-term and medium-term fluctuations, including business cycles, and we keep the long-term changes only. According to this measure, trend growth reached a peak rate above 4 percent at the beginning of the 1960s, declined to rates well below 3 percent in the late 1970s, and partially recovered in the 1980s, only to drop further in the late 1990s and 2000s toward the current 2 percent rate. Other measures based on real GDP data lead to slightly different estimates, but they all agree that trend growth is currently close to historically low rates.
Besides real GDP data, other information is useful for estimating trend growth. Real GDP trend growth can be decomposed into the sum of the trend growths of three components: output per employee (employee productivity henceforth), the labor force, and the ratio of employment to the labor force. The latter component, which is related to changes in the trend of the unemployment rate, contributes little to real GDP trend growth, so we focus on the other two components, first on employee productivity and then on the labor force.
To learn about the trend growth of employee productivity, we look at its average growth rate in the past. Employee productivity grew rapidly at a 2.57 percent average rate in the 1948:Q2-1973:Q1 period. Then, the average growth rate dropped to 1.04 percent in the 1973:Q2-1995:Q2 slowdown period, picked up to 2.23 percent in the 1995:Q3-2003:Q3 acceleration period, and then declined again to 1.11 percent afterward.
There is large uncertainty around the current trend of employee productivity. Given that employee productivity has been growing slowly since 2003, the current trend growth rate likely lies in the interval between 1 percent and 1.5 percent. The uncertainty around the long-run trend is even larger, as it will depend on the technologies that will become available in the future. Historical data show that the average growth rate of employee productivity can vary widely from values as low as 1 percent to values as high as 2.5 percent, so a plausible interval for the long-run trend growth of employee productivity is 1 percent to 2.5 percent. The large width of this interval simply reflects the large degree of uncertainty surrounding the forecast.
Turning to the trend growth of the labor force, the data reveal a clear pattern: It increased during the 1950s and 1960s, peaked at rates around 2.5 percent in the 1970s, and then steadily declined toward the current rate below 1 percent. One important factor behind this decline was that the labor force participation rate decelerated in the 1990s and declined in the 2000s. Looking ahead, the Bureau of Labor Statistics forecasts that the labor force will likely grow at a 0.7 percent average annual rate from 2010 to 2020, so we use this rate as our estimate for the current and long-run labor force trend growth. There is uncertainty around this estimate, too, since the labor force trend will be affected by changes in the trends of population and labor force participation. However, the uncertainty here is smaller than in the case of the employee productivity trend.
Summing up our estimates for the trend growth rates of employee productivity and the labor force, we obtain the implied growth rate of the real GDP trend. The current rate likely lies in the interval between 1.7 percent and 2.2 percent, while the long-run rate will plausibly be between 1.7 percent and 3.2 percent. Our interval for the long-run trend growth encompasses other estimates of the long-run growth rate of real GDP, including the Congressional Budget Office estimate of potential GDP growth, 2.3 percent, and the bottom-10 and the top-10 averages of the Blue Chip Financial Forecasts, 2.2 percent and 2.8 percent, respectively. The midpoints of our intervals are 1.95 percent for the current rate and 2.45 percent for the long-run rate, but the uncertainty surrounding these estimates is large.