America’s potential GDP growth has been pegged at a dismal two percent, which could be unacceptable to many, including the US Fed. Aggregate supply-growth over time creates wealth, so if there’s less potential GDP, there’s less to share, which is a bad thing, said Vincent Reinhert, Chief US Economist at Morgan Stanley.
Asked if Americans should learn to live with this new low growth regime, or if there was a policy prescription to boost growth to 2.5 percent, Vince said the important question that needs to be asked is how the economy slipped to 2 percent from 2.5 percent five years ago or almost 3 percent ten years ago.
The US economy endured a severe financial crisis that destroyed a lot of wealth, followed by a poorly performing economy that shallowed out the human and physical capital stock, which resulted in the slowdown in growth. Some things are easy to change while there are others which are much difficult to deal with. US population growth is slowing while the size of aging the population is increasing. Demographics would suggest there is a secular downtrend in labor force participation rate, Vince noted.
US inflation has really not picked up as expected and part could explain why rents have stabilized in recent times. Asked to explain why that could be bad news for the economy, Vince said the Federal Funds Rate/the nominal policy rate has been held at zero by the US Fed. If inflation and inflation expectations fall, then real interest rate rises.
The policy is tighter today than it was a year or two years ago. If there’s slack in the economy and inflation is below target, then the Fed has fallen short both of its goals. But its monetary policies have tightened in the interim, making the situation complex, he explained.
Asked if New York Fed chief Bill Dudley’s observation – that the economy is set to witness a change, was correct, or investors should wait for more data, Vince said more data points are required before drawing any conclusion. In terms of macro data outlook, there’s a geographic footprint of the weather. Growth in the first-quarter would be about one-and-a-half percent, and should gradually pick up pace to more than two percent in the second and third quarter, he noted.
Asked if he’s more worried with labor force participation rate that has fallen to a 40-year low, or weak productivity growth, Vince said pace of productivity growth is more worrisome. Poor labor force participation rate, to some extent, could be attributed to factors like voluntary acceptance of early retirement or young people choosing to stay longer in college to acquire skills. But the cyclical component of it like people getting discouraged because they couldn’t find a suitable job is much more troubling.
But ultimately, productivity is what drives real-wage growth. Real wages can help solve problems like income inequality and declining labor period income, he explained.
Asked what could drive the economy’s growth going forward, Vince said middle-part of the continent that is good at extracting energy which the US is reluctant to ship because that gives a comparative cost advantage to manufacturing there, could be one.
Also, the financial institutions have deleveraged and de-risked, and should be more efficient going forward. US banks went through much less grind compared to its European peers and should recover earlier, he concluded.
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