The Washington PostDemocracy Dies in Darkness

Unfinished (economic) business

Source: BLS
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As 2015 comes to a close, the broad consensus is that the U.S. economy is solidly back from the brink, if not quite yet firing on all cylinders. Certainly, that was the judgement of the Federal Reserve when it raised the interest rate it controls in mid-December.

No question, our 2015 economy once again showed its flexibility and resilience, especially compared to many other advanced economies, like those of Europe, where unemployment in many countries remains in double digits. The expansion that began here in the second half of 2009 is in its sixth year, with few signs of the sorts of bubbles or resource constraints that signal trouble.

But considerable unfinished business remains, by which I mean that even this far into an expansion, there are still significant pockets of weakness. So, not to be a downer but to present a balanced view, here’s a list of economic concerns we carry with us into 2016.

The job market: The unemployment rate at 5 percent is about at what the Fed considers to be the full employment rate, meaning the lowest rate consistent with stable inflation. But that judgement is hard to square with the reality that inflation has been unusually low and not accelerating at all, and that’s not just a function of cheap oil; it holds for measures that leave out energy prices.

You ask me, the job market isn’t as tight as the unemployment rate suggests. The underemployment rate, for example, is 9.9 percent and by my calculations, full employment for this measure is 8.5 percent, so it still has some room to fall.

Also, the share of employed prime-age workers (25 to 54) is still climbing out of its recessionary hole. By the end of 2015, this indicator of labor demand had clawed back just half of its losses (see chart above).

The wage story is also a mixed bag. In nominal terms, wage growth was stuck at 2 percent for most the year, largely unresponsive to the tightening job market. Very low inflation, however, meant that stagnant nominal wage growth translated into real wage growth and towards the end of the year, there were nascent signs of life in the wage series I follow. But this recovery has yet to generate lasting, broad-based wage growth.

The macro economy: Although the quarterly readings will always bounce around, gross domestic product growth has reliably settled into its trend of around 2 percent, with consumer spending holding up particularly well, reflecting strong job growth amidst low inflation.

But that’s not a particularly fast clip, and even this deep into the expansion, growth has yet to close the “output gap,” the difference between potential and actual GDP, where “potential” means GDP at fully utilized resources. In this regard, it’s important to wrap your head around Chart 2 here, where Ben Spielberg and I show that not only has GDP growth failed to close the output gap, but more importantly, potential GDP growth itself has been marked down:

“Note … the damage done to potential GDP since the Great Recession; today’s estimates are lower both in real dollars and slope. Even so, actual GDP hasn’t caught up, making her a runner that can’t seem to cross a goal line — one that’s moving toward her!”

Slow productivity growth is a major factor in this markdown, a big concern going forward and one that’s both a growth problem and an inequality problem.

We also head into 2016 posting historically low rates of interest and inflation, both of which signal persistently weak demand.

Inequality: The forces behind income inequality, which include globalization, the absence of full employment, the rise of finance, and centrally, the perennially weak bargaining power of most workers, are of course still with us. The productivity-compensation gap, shown in Chart 3 here, probably closed a bit in 2015, as real median pay, driven up by uniquely low inflation, surpassed weak productivity growth (we don’t have full year data yet but real median earnings were up 1.5 percent through the third quarter compared to last year, while productivity was up only 0.6 percent).

But consider that the onset of what are now historically high levels of inequality occurred when productivity growth slowed in the mid-1970s. That’s no coincidence: When there’s less growth to go around, those with the most economic and political power will protect and expand their share at the expense of the majority on the other side of the inequality divide. This phenomenon is uniquely amped up in our system, where money buys policies that shield wealth (e.g., tax policies favoring asset-based incomes) and blocks policies then strengthen bargaining clout (e.g., minimum wages, unionization).

How the economy … um … works: One final, important shortcoming we carry with us into 2016: Economists are having a lot of trouble understanding what makes the economy tick. Look at the figure below, from researchers at Goldman Sachs. It shows GDP forecast errors, which are basically just actual growth minus predicted growth (so if actual was 2 percent and you predicted 3 percent, the figure would show a bar of negative 1 percent).

This year marks the 13th out of 16 years since 2000 that forecasters have been too optimistic re growth expectations.  Cumulatively, the downside misses on the level of real GDP sum to almost 15 percent since 2000.

That tells you a few things. One, the models are missing something important that’s holding back growth, and two, researchers are insufficiently self-correcting. The economy is Lucy and the forecasters are Charlie Brown, or, more formally, what researchers are considering temporary factors are, in fact, more persistent. The Fed, for example, argues that its upside misses on inflation (it keeps thinking price growth is about to accelerate) are due to temporary factors, including cheap oil and the strong dollar. Maybe 2016 will show their forecast for faster inflation growth to finally be correct, but put me down as a skeptic.

So, lots to learn about and a number of important trends to track as we heard for 2016. Stay tuned, fellow nerds!