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Is “Sluggish Economy” the New Normal?

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Some analysts have started talking about the sluggish U.S. economic growth as the “new normal.”

I have a hard time with that term.
For one thing, “normal” is a relative term. What is normal in one environment is not in another.

Based on history and the experience of other countries, for example, a sluggish economic recovery is “normal” after a recession that includes a financial crisis.

Throw on top of that widespread home price depreciation, foreclosures, and consumers who are reducing their debt load, it’s no surprise that the U.S. economy continues to struggle two years after the recession officially ended.

After these temporary factors work their way through, analysts will start to focus on the potential growth rate of the economy or what the Federal Reserve has referred to as the maximum sustainable growth rate.

The potential growth rate varies over time and is dependent on factors such as productivity and labor force expansion.

A simple way to estimate the potential growth rate is to add the annual productivity growth rate, which was 1.5 percent from 2002 through 2010, to the labor force growth rate of 0.9 percent during that period. As a result, the potential growth rate of real gross domestic product was 2.4 percent during that period.

Looking ahead, the Congressional Budget Office is estimating productivity to grow 1.5 percent and the labor force to advance 0.7 percent a year from 2011 through 2016.

That would equate to a potential growth of 2.3 percent a year.

That target is important in projecting future economic growth because the Federal Reserve tends to increase the overnight interest rate that banks charge each other when the economy is consistently growing faster than it potentially should and to  lower rates when the economy is growing too slow.

Of course, the forecasts for productivity and labor force growth may miss their marks.

I tend to believe the forecasts are too low, and expect productivity will likely grow faster than the projected 1.5 percent average.
Continued investment by businesses in capacity and equipment points to a speedier productivity growth. Besides, productivity grew at an annual average of 3.3 percent during the past 60 years.

In terms of labor force growth, the Congressional Budget Office assumes a continued decline in the participation rate.

The labor participation rate has fallen since the recession began and the budget office expects it to drop further, in large part, because of the aging and retirement of baby boomers.

The need to work longer because of inadequate retirement funds, however, is likely to cause the labor force to contract less gradually than the budget office’s expectation.

Reprinted with permission from the Richmond Times-Dispatch
Christine Chmura is president and chief economist at Chmura Economics & Analytics. She can be reached at (804) 649-3640 or at  

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