The New “Normal” In The U.S. Economy

Written by Satyam Agarwal

“Up, Up, Up Goes the Economy”, read an article written by Ben Casselman in the New York Times. There has been a lot of buzz around the U.S. economy’s seemingly inexorable growth over the last 9 years, with this current cycle of economic expansion being the third longest run amongst all expansions. The labor market has been robust, with unemployment  at a 17 year low of 4.1%, and job growth exceeding expectations. These conditions, along with a sustained rise in equity prices and moderate inflation, has led the economy to be in an ideal “Goldilocks” state.

Going by these strong fundamentals, can we say that the economy has emerged completely unscathed from the financial crisis? Is there any risk it still faces, long after the crisis?

To revive the economy from the recession in 2008-2009, the FED started a large-scale program of asset-purchases, buying trillions of dollars of long-term treasury and mortgage-backed securities to lower interest rates. While this measure did play a major part in the economy’s recovery, the economy might never return to its so called “normal” state.

While there is no denying the economy’s enduring growth run, the pace of growth is much slower than under similar conditions in the past. Even though interest rates have been extremely low (nearing zero at a point in time), the labor market has been robust, and global growth and recovery has been well-synchronized, this current cycle of economic expansion has experienced the lowest growth rate among all economic expansions since 1948. As the aforementioned New York Times article says, “ Although the current expansion has been durable, it has not been particularly strong. Quarterly annualized growth in gross domestic product has averaged just 2.2 percent since the recession ended, compared with 5 percent for the typical recovery since 1950. The economy has basically experienced a long smolder rather than the kind of rapid conflagration common in the past.”

This phenomenon can be attributed to a number of reasons, the most notable being structural changes in the economy. The aging of baby boomers has greatly reduced the labor force in the economy. Moreover, due to a lack of substantial technological breakthroughs in the recent past, productivity growth has been sluggish. This has led to the economy growing at a rate less than what would have prevailed under similar conditions in the past.

With the changing dynamics of the economy, would the “normal” interest rate, one which neither overheats nor tightens the economy detrimentally, return to the levels of 4-5% it has been at during previous economic cycles? With the current target FED Funds rate standing at 1.50-1.75%, that seems very unlikely. Based on current macroeconomic conditions, the new normal interest rate would most likely settle around 2.5-3.0%, giving the FED very little room to provide monetary stimulus of a large scale in case of another downturn.

All in all, while the economy has made a persistent recovery since the crisis, it hasn’t been particularly strong. A swollen balance sheet, high levels of debt, and little room to provide monetary stimulus have been the prices paid by the FED to liberate the economy from the recession. Other structural changes in the economy have led to lower-than-expected levels of growth and productivity.

This beckons the question – Is this the new “normal” in the economy of today?

With the FOMC expected to make 3-4 rate hikes this year, a large part of this question is expected to be answered as the future unfolds.