Full text of FedViews : March 14, 2019

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Twelfth Federal Reserve District

FedViews
March 14, 2019

Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
https://www.frbsf.org/economic-research/publications/fedviews/

John Fernald, senior research advisor at the Federal Reserve Bank of San Francisco, stated his views on
the current economy and the outlook as of March 14, 2019.


The economy grew at a well-above-trend pace of 3.1% from Q4 2017 to Q4 2018. Since late last year,
however, the data have been more mixed, suggesting that the economy has lost some momentum.
Nevertheless, the labor market remains solid, financial conditions have improved since December, and
consumer sentiment and business surveys, while easing from last year’s highs, suggest continuing
growth.



A prominent example of a soft data release was retail sales, which fell sharply in December and only
partially rebounded in January. The level of retail sales is well short of its pre-December trend. This
series tells us something about the trajectory for consumer spending as we come into this year. Another
example is orders for non-defense capital goods excluding aircraft—an indicator of upcoming capital
spending on equipment by businesses—which eased at the end of last year and early this year. Orders
have retreated a bit from their levels from last summer and fall, which suggests reduced growth in
shipments of capital goods early this year.



Despite these signs of a slowing economy, economic conditions remain supportive of continued
growth. For example, the labor market remains, on balance, fairly solid. The unemployment rate is very
low—3.8% in February—and wage gains are gradually picking up, with average hourly earnings rising
3.4% in the past 12 months. Job gains have been choppy from month to month but, on average they
have been solid. With a strong labor market, it is no surprise that surveys of consumer sentiment remain
strong.



In addition, another positive development is that financial conditions have eased considerably in 2019.
For example, the stock market has rebounded from its December swoon—even if stock prices remain
below their peaks from last fall. The stabilization in financial conditions was helped by the Federal
Reserve’s announcement in January that it would be “patient as it determines what future adjustments
to the target range for the federal funds rate may be appropriate.” A solid labor market, favorable
consumer sentiment, and improved financial conditions should help support consumer spending.



Surveys of businesses also remain positive. This is particularly true outside of manufacturing, where
surveys of purchasing managers remain close to the post-recession peaks from last fall. Manufacturing
surveys have softened somewhat, but continue to signal expansion.

The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco.
They are not intended to represent the views of others within the Bank or within the Federal Reserve System. As of January 2019,
FedViews will appear eight times a year around the middle of the month. The next FedViews is scheduled to be released on or
before April 16, 2019.



Headline inflation of the personal consumer expenditures (PCE) price index over the past 12 months
came in at 1.9% in December, slightly below the Federal Open Market Committee’s (FOMC)
symmetric target of 2%. Core inflation, which excludes volatile food and energy prices, rose 1.8%.
Given the tight labor market and ongoing monetary accommodation, we expect inflation to consistently
achieve the 2% objective over the next few years.



Putting it all together, real GDP is poised to continue to grow this year, but at a pace closer to its
sustainable trend, which we put at 1.7%. This view about trend reflects assessments of the labor force
(which determines potential hours worked) and productivity (most broadly, real GDP per hour worked).



Demographics are the most important reason to expect slow future growth relative to its historical pace.
By the middle of the next decade, the working age population (16-to-64 year olds) will be growing at a
historically low pace, reflecting the aging of the baby boom generation. Of course, the working-age
population does not translate one-for-one into employment; for example, many people over 64 do work,
and participation trends are changing for other groups. Going forward, the Congressional Budget Office
projects that the potential U.S. labor force will grow at about a 0.5% pace. This is almost a percentage
point below its average pace over the past half century.



GDP per hour has grown at varying rates over time. From 1973 to 1995, GDP per hour grew at an
average pace of 1¼% per year. From 1995 to 2004, productivity accelerated to a 2½% pace, reflecting
the broad-based and transformative role of IT, including the Internet. During this later period, ITproducing firms rapidly improved their equipment and software, and the use of IT allowed other firms
throughout the economy to reorganize and improve their operations. After 2004, however, this
exceptional pace disappeared. GDP per hour grew at only a 1.1% pace from 2004 to 2018 and has
grown at an even lower pace since 2010.



The slowdown in productivity growth after 2004 does not simply reflect the effects of the Great
Recession since productivity growth slowed prior to 2007. Nor does it reflect a rising problem in the
mismeasurement of growth. Mismeasurement is not new; it has always been a challenge to accurately
capture the benefits of new goods and the improving quality of existing goods. Recent research finds
little evidence that measurement problems have gotten worse. Rather, the post-2004 slowdown appears
to reflect a return to normal after an exceptional period of IT-related business innovations and
reorganizations.



In 2018, GDP per hour grew 1.2%, well above its 2010-18 average but in line with the typical pace
observed since the 1970s (with the notable exception of the 1995–2004 period). Though productivity
might surprise and accelerate beyond this pace, history suggests that such accelerations occur
infrequently and are hard to predict. We expect that GDP per hour will continue to grow at a similar
pace of 1.2%, and that the trend labor force (and employment) grows at around 0.5% per year.
Together, these imply that the new normal of real GDP growth is a little below 1¾%.