No More 10 Minute Breaks: How Our Expectations of Weak Economic Growth May Have Helped Cause It

The U.S. economy has been stuck in a rut.

Gross domestic product has been advancing roughly 2% a year during the latest expansion, productivity has skittered near long-term lows and some economists believe the U.S. is mired in a period of secular stagnation marked by excess savings, inadequate investment and low interest rates.

New research suggests such stagnation may partly result from expectations the economy will stay in a rut.

“Put simply, the anticipation of a less bright future is leading to temporarily weaker demand,” the Peterson Institute for International Economics’s Olivier Blanchard, Northwestern University’s Guido Lorenzoni, and the Einaudi Institute for Economics and Finance’s Jean-Paul L’Huillier said in a paper. “If this explanation is correct, it has important implications for policy and for forecasts. It may weaken the case for secular stagnation, as it suggests that the need for very low interest rates may be partly temporary.”

Former Treasury Secretary Lawrence Summers is perhaps the best-known proponent of an updated secular stagnation theory. “So I continue to urge that it is worth taking seriously the possibility that we face a chronic problem of an excess of desired saving relative to investment,” Mr. Summers wrote in a 2015 blog post.

Policy makers and economists have struggled to treat the global economy’s malaise. While the labor market has picked up, broader measures of growth have not—at least not yet.

Messrs. Blanchard, Lorenzoni and L’Huillier’s key insight relates to productivity. They posit that lower forecasts for long-run productivity growth can crimp wage growth, keeping some workers out of the labor market and temporarily raising unemployment. That, in turn, can push consumers to lower their views on income, crimping demand. Lower demand growth coupled with temporarily lower profits may lead firms to downgrade investment plans.

All together, downwardly revised productivity growth may have lowered demand by 0.6% to 1% a year since 2012, the authors calculate.

“If we are right, it may well be that, as this adjustment comes to an end, this adverse effect will disappear, demand will pick up and interest rates will increase substantially,” the authors wrote. “To the extent that investors in financial markets have not fully taken this effect into account, the current slope of the yield curve may understate the increase in interest rates to come.”

The Federal Reserve in December raised its benchmark interest rate for the second time in a decade. Central bank policy makers anticipate three more such moves this year, though officials emphasize there is no preset course. In any event, rates appear likely to remain well below long-run norms.

Chairwoman Janet Yellen has acknowledged the role of slow productivity growth on rates, notably the neutral rate—the inflation-adjusted rate that’s consistent with the economy operating at its full potential, expanding without overheating.

“Current estimates of the neutral rate are well below precrisis levels—a phenomenon that may reflect slow productivity growth, subdued economic growth abroad, strong demand for safe longer-term assets, and other factors,” Ms. Yellen said in recent congressional testimony. The Fed “anticipates that the depressing effect of these factors will diminish somewhat over time, raising the neutral funds rate, albeit to levels that are still low by historical standards.”

Fed Raises Rates for First Time in 2016, Anticipates 3 Increases in 2017 (Dec. 15, 2016)

U.S. Productivity Advanced for Second Straight Quarter (Feb. 2)

A Challenge to the ‘Secular Stagnation’ Theory (Jan. 24)

Is ‘Secular Stagnation’ Too Pessimistic? (April 24, 2016)

from Real Time Economics http://ift.tt/2lFa04d