Previously published on December 16, 2016 in the California Economic Forecast publication.
The United Sates economy continues to grow at less than its potential. The 12-month moving average of job creation has been falling steadily since February 2015. In seven of the last eight quarters, investment growth has been negative or near zero. Productivity declined in three of the last four quarters. And work force participation is at its lowest rate since the 70s.
These are terrible figures for an economy that is “recovered.”
To hear many economists, journalists and policy makers tell it, this is the “New Normal” for the U.S. economy. It’s the best that we can hope for given the magnitude of the most recent recession. According to economist Bob Gordon of Northwestern University, this poor economic performance is not just a temporary, post-recession phenomenon but rather a permanent trend resulting from missing innovation in the economy. So, get used to it.
We reject these hypotheses.
The under-performance of the U.S. economy over the past eight years is not like a change in the weather. We are not at the mercy of overwhelming outside forces. This is not the predictable result of a serious financial crisis.
As discussed in previous forecast essays, the current regime of slow economic growth is largely the result of policy. The current forecast marks the end of eight years of unprecedented monetary, fiscal and regulatory policy experimentation. From a Central Bank that has undertaken discretionary policies never before contemplated and poorly understood, to federal budgets with annual deficits over 1 trillion dollars, to regulation by pen and phone, we see no possible way for the economy to perform at or even near its potential given the restrictions and the uncertainty that policy has created.
We’ve held this position since the earliest days of the recovery. This conviction is captured in each of our previous forecasts—forecasts of economic activity which have been systematically lower than the consensus and which have been accurate.
Fortunately, the lie of the New Normal may be revealing itself as we speak. With the election-shocker delivered by Donald Trump on November 8, and with the prospect of an entirely new policy regime in Washington, economic forecasts are suddenly being revised upward. Some of the biggest and most respected forecasting houses are speaking of potentially “big upsides” to the new administration. Even Trump detractors, most notably Paul Krugman, are admitting that they will not be surprised if economic growth accelerates in the years ahead. Expectations of future growth have changed even without an actual change in policy.
Each of these upward revisions to the country’s economic outlook is an admission that policy matters. Each upward revision is an admission that the current economic situation was not inevitable.
Ironically, even if we are right about the importance of policy and even if that view becomes more commonly accepted, once again we are very likely to end up with economic forecasts systematically below the consensus. Policy matters, but so do politics. In the current political environment, we assign low probability to the possibility that the Trump administration can actually achieve significant reforms.
We see poor economic performance for the foreseeable future, it’s just not normal. Poor economic performance is the result of choices that were made and continue to be made by policy makers.
One forecast that we would love to get wrong is this forecast of the probability of true reform. If meaningful tax and regulatory reform actually happen, then our economic forecasts will be wrong, possibly very wrong. But just let it be known that we will be wrong about the politics, not about the economics. If true reform does happen, Americans are likely to enjoy economic opportunity not seen in the past decade. This would be a welcome return to the Old Normal.