Promises versus Deliverables: Jeb Bush and 4% Growth

Jeb Bush has set the presidential race pace with a promise of 4% growth. Other contenders, Democratic and Republic, will make similar promises, or perhaps already have – I've not looked. My intent here is to examine the issue, not the man.

In the medium and long run growth rates are about the supply side. Now in the short run demand factors matter, and since we're still in recovery from our Great Recession, we can hopefully have a few years of above-normal growth. My own estimation, taking into account the retirement of the baby boomers, is that we're about 7 million jobs short of where we need to be. Of course the next Administration won't take office until early 2017, and realistically their policies won't kick in until 2018. We're adding jobs at a 2 million per year pace. So if we keep that up, by then we'll be pretty close to normal. Looking at the supply side is thus sensible.

4.0% growth isn't going to happen

So what are long-term growth prospects? Basic (macro)economics is that over the long haul growth is a weighted average the growth of inputs – here I look at capital and labor – and total factor productivity, the growth of the economy over and above that due to more inputs. Work in this tradition goes back to a 1957 paper by the Nobel laureate Robert Solow; we thus have nearly 60 years of work, and a sense that the approach is pretty robust way to organize our thinking. So what we need to do is gauge the range of these three factors.

Let me begin with labor force growth. My own estimate, based on Census projections of the population by age and the propensity of people of different ages to work, is that by 2018 the underlying trend will be on the order of 0.4%. Now the baby boomers are working longer than their predecessors, so this may prove a tad low, but it is the right order of magnitude. For example, if we look at past employment growth, we see that it has gradually fallen over the past 75 years, averaging over each decade. While the rate as of January 2015 was 2.0%, that reflects the recovery from the deep trough of 2009 and is not sustainable. In fact, the (geometric) average of employment growth since 2000 is 0.5%. So I'll use that as my base case.

Next is the growth of productive resources, factories and housing and cars and shopping malls. At present investment is far below normal, particularly for structures and residential, and for investment by the government (down in all subcategories, from roads to office equipment). So we could see an uptick. Looking at the pre-Great Recession average, we might see 2.2% growth in business and residential investment, and 2.5% if we add in consumer durables such as automobiles. On the other hand, with population growth down and the average age rising, we may well see all forms of construction remain at lower levels. I'll use the higher numbers here.

Finally, there's productivity. The trend over the past roughly 30 years is 1.1% growth (or more precisely 1983-2011), with a lot of volatility. Will it come in higher? I see no reason to think that will happen. Yes, we are seeing lots of innovation. No, it is not boosting growth. Biotechnology has been advancing for 10,000 years, since the early domestication of wheat, sheep and cattle. To pick one modern crop, selective breeding at the International Rice Research Institute in Los Baños, Philippines led to high-yielding varieties in the 1960s. Modern genetic engineering is a continuation of this trend, and the productivity gains from the standpoint of the overall economy of future innovation will be modest. Likewise adding to longevity will do little in the short run to boost output, as reversing the trend toward retirement will require decades. IT is leading to an array of gadgets, but "robots" have been central to our factories for the past 2 decades, and while my first computer could not always keep up with my typing speed, in my own work I've seen diminished returns to improvements in hardware, software and improved data resources. As emphasized by Robert Gordon, there are many reasons to think that productivity gains will not pick up. Even if they do, that's also a long-run process, as workplaces gradually reorganize to incorporate new tools. In sum, we won't see a surge during 2018-2021; a 1.0% rate is all we'll get.

...and there's not much a future president can do about it

Let's put it together: 1.0% productivity, 0.5% employment growth, 2.5% capital growth. Discount the latter (as per economic theory) for diminishing returns (which matches their share in output) by (respectively) 0.6 and 0.4. That gives us 1.0 + 0.3 + 1.0 or 2.3% growth.

Guess what? Growth of 2.3% happens to be what we've averaged since the 2009 trough of our Great Recession. It's also consistent with interest rates, as the gap in yields between 3- and 5-year bonds implies 1-year interest rates of 2.2% in 2019 and 2.6% in 2021. (Look for a pending post.)

So 4.0% growth isn't going to happen, and there's not much a future president can do about it.

Let me put in a plug for my home institution, Washington and Lee University. For over a century our students have held a Mock Convention to nominate the presidential candidate of the party out of power. In due course, as the primaries unfold, I will urge our economics majors to analyze the economic proposals of the candidates. I'll add my own analysis here from time to time. So watch for updates.

Interest Rates and Employment: The Taper's Well Camouflaged

Protect Tapirs: http://www.tapirs.org

Tapirs are well-camouflaged. So's the taper: you have to look for it. That should not be surprising to anyone who lets their view of the world be affected by data, rather than the pop version of a simplistic model.

...the taper's well-camouflaged...

First, the data; I present 1 month, and 1-, 5-, 10- and 30-year interest rates, pulled from the Treasury's Daily Yield Curve web page. Interest rates are certainly up over the nadir of 2012, but casual reading of the graph suggests at best a modest impact (see the Wikipedia entry on the three US rounds of "quantitative easing", or the analysis of economist's such as that of James Bullard at the St. Louis Fed). In the background of course is the continued slow growth of the economy, which at its current pace of job creation will take until 2019 to bring us back to normal. Meanwhile, there are no signs of an uptick in inflation (and in Europe, a few whiffs of deflation).

This is of course in tension with the naive MV = PY monetarist frameword, most clearly developed by Irving Fisher but used as well by JM Keynes and Milton Friedman. In practice, given the ongoing evolution of financial systems around the globe, defining "money" and then measuring it is problematic, and "velocity" is volatile – and QE isn't directly affecting money, only providing an enabler for banks to create additional credit, and thus the bank deposits that we actually use. Meanwhile, at low levels of nominal GDP growth the split between prices and output is sufficiently uncertain that the conceptual link between money growth and prices is empirically useless – if somehow we overcome measurement errors in "M" and can predict V to give us a prediction of the growth of PY – nominal GDP – of 3%, we don't know whether we get real GDP of 3% and no inflation, or 3% inflation and no growth.

So there is no simple link between QE3 and growth. Indeed, there's no simple link with interest rates. At longer maturities interest rates reflect arbitrage opportunities: if we want to hold bonds through (say) 2019 we can for example choose between a 5-year bond and rolling over a series of 1-year bonds. What that tradeoff looks like thus reflects our expectations of future interest rates. If we expect slow growth to continue for most of the next 5 years, then we would expect the Fed to hold short-term interest rates to a low level, with or without QE3 – that is, whether we taper or not. If so, then a 5-year bond should carry an interest rate little different from today's short-term rate. If in 2018 we expect to be back to "normal" with 2% growth and 2% inflation, then we might think that come 2018 one-year rates could be around 4%. In that case 5-year rates (as an average of 1-year rates each year from now to then) would be lower than 4% – using annual rates of .1%, 1%, 2%, 4% and 4% gives a (compounded) 5-year return of 2.2% – but 10-year rates should be sharply higher (assuming rates after 2018 stay a constant 4% gives a 10-year return of 3.1%), and 30-year rates very close to 4% (keeping post-2018 rates at 4% would suggest 3.7%).

...the Fed may taper but interest rate's aren't going to move much...

Now the current rate of employment growth suggests that we won't be back to trend employment levels until 2019. Because of the retirement of the baby boomers employment growth need not be as stront as in the past (a naive projection gives the light blue line, 2.7 million above an estimated based on Census population projections and age-specific employment rates). Unfortunately we're still a long ways from normal. And guess what? My back-of-the-envelope calculations suggests interest rates are consistent with the employment story. The Fed may taper, but absent stronger growth, interest rates aren't going to move much.

...interest rates are consistent with employment growth (or its lack) rather than the taper

Mike Smitka