The Current State of the US Economy

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1 The Current State of the US Economy This short article is based on the most recent report of the Chairman of the Federal Reserve to the Congress on US monetary policy and the current state of the US economy. I have also added some recent data from the FRED data bank of the St. Louis Federal Reserve Bank. Naturally these data will probably be revised in the future, but for now we can use them to get some idea on the progress of the US economy in recovering from the severe downturn in The US is continuing to recover from a very deep recession. Although the economy is recovering, it is doing so slowly and unevenly. During 2014, the pace of real economic growth was about 2.4% on an annual basis. The current prediction by the Federal Reserve is that US growth for 2015 will be in the range of 2.6% - 3.0%. In the graph above note how that the recovery has been slow and anemic. Also, there has not been any time where growth exceeded 5%, unlike the recovery after In order to lower unemployment in the US growth must exceed the natural rate of growth of 2.5%. Note also how growth dropped unusually low in This illustrates how deep the recession was and how difficult it is to return to normal. The average pace of monthly job gains picked up from about 240,000 per month during the first half of last year to 280,000 per month during the second half, and employment rose 260,000 in January. These job gains in recent months have been spread across many

2 industries, which is an encouraging development. However, in March of 2015, the job gains were a disappointing 128,00. Part of this is due to the poor weather and part is due to falling oil prices, but in fact the reduced gains were felt across many sectors of the economy. The unemployment rate for the US was steady at 5.5%. The Federal Reserve is contemplating a rise in short term interest rates if the labor market improves. But, the most recent data shows that the US economy is still not doing all that well. The graph above shows that unemployment is trending downward. This seems like a good thing, but actually the rate is falling mainly because of less people in the labor force. Labor participation in the US has been falling for many years now. This makes the unemployment rate a poor indicator of the labor market. Rising wages would be a good indicator of an improving labor market, as would average hours worked. These have not been rising much recently. Household consumption expenditures has been making a slow, but unsteady rise over the last few years. But, household consumption is being held back by fears of a new recession and by little change in wages and median household income. Consumer spending is a very important component of total spending in the economy. If households buy less, especially durable goods, then it will be difficult for the economy to continue to grow and recover. The recent surge in consumption

3 The graph above indicates how that consumption growth has been rising in a healthy manner. Unfortunately, the most recent data on January and February of 2015 shows consumption growing at a -2.4% and 1.2%, respectively. Without strong growth in private consumption, jobs cannot be created and the economy cannot return to normal. This is one of the most important features of the current recovery. The next couple of months will be crucial in this regard. The housing sector is making a slow and choppy recovery. However, this must be weighed against the fact that long term interest rates in the US have been extremely low for over six years. The usual 30 year fixed rate stands at 3.8%, which is about 40 basis points above its all time historical low. Housing prices are rising steeply in some areas of the US, particularly large cities in California and New York. The choppy up and down nature of the time series is due in part to seasons. Sales of houses do not not occur as much in the winter when the weather is very cold. The trend is very clear, though. Historically a 5% increase in house prices was very typical. Factoring in the inflation is about 1-2%, this means a real growth of 3-4% per year.

4 The graph below shows how that growth in real fixed investment has not been very stable. This instability increased after the last recession. Note how that falling fixed investment has been a good indicator of a new recession. We have not seen real investment growth falling as a trend, but it could happen at any time. Certainly there were times recently when growth of investment was negative. The spurts of growth in investment have been very large but also very short lived. Firms still do not have enough confidence in the future to invest for the long run.

5 As we have said, the Fed is forecasting growth in the US economy for 2015 at between 2.6% to 3%. Turning to prices, inflation remains an issue in the US. The Federal Reserve has targeted a 2% growth in the CPI. It has been afraid that the US will experience deflation and that this might weigh down the recovery. Falling prices will only make households and bank more willing to hold money -- not to spend it. The Fed wants to avoid this. The graph below shows that inflation has been coming down and now looks to become deflation. Part of this fall in prices is due to the large reduction in oil prices, decreasing the cost of energy to the consumer and to business. If inflation becomes deflation, expect that the Fed will respond by beginning another program of quantitative easing.