The economists at the Federal Reserve practice what is known as the “dismal science,” but their projections for economic growth have been anything but pessimistic.
In fact, the Fed has consistently overestimated how quickly the economy would grow ever since the financial crisis. The following chart from Guggenheim Partners shows how the Fed’s economic growth expectations last year dropped precipitously as 2013 grew closer. In the end, even their final prediction of GDP growth of roughly 2.1% was optimistic, as the economy only grew 1.8% last year.
And the Fed’s at it once again, as it reduced its estimate for GDP growth in 2014 by more than half a percentage point, from 2.8%-3.0% down to 2.1%-2.3%. While that may not sound like much, remember that a good rule of thumb is that a single percentage point of GDP growth leads to roughly 1 million new jobs.
Given that the economy actually shrank at an annual rate of 1% in the first quarter of this year, a projection of 2.1% growth for 2014 implies a relatively large expected bounce back in the remaining quarters. At the same time, the Fed stuck with its projections for 2015 economic growth of 3.0%-3.2%, meaning it doesn’t expect lost economic growth this year to be made up in the years to come.
So, if the first quarter contraction was really just about the weather (as many have said), you would expect the vast majority of that economic growth to be made up in later quarters when the weather was better. Bad weather is generally thought to simply delay, rather than kill, economic activity. Furthermore, the Fed cut its projections for long-term interest rates from 4.0% to 3.75%, a change that Fed Chair Janet Yellen attributed to “a slight decline in projections for longer term growth,” in a press conference following Wednesday’s policy announcement.
All in all, the announcement and press conference could be taken as an endorsement of a theory that economist and former Treasury Secretary Larry Summers has recently put forward, which is that the U.S. economy is entering a period of “secular stagnation” in which there is insufficient demand to support the sort of growth rates the U.S. has become accustomed to.
After all, economies are supposed to grow above typical trends following recessions, and the U.S. economy has failed to even reach its long-run growth rate trend of 3.27% for any year since the recession ended. Even the Fed’s best-case scenario has the economy growing at roughly that long-term rate next year before falling back to 3% in 2016 and 2.3% per year in the years thereafter.
When asked what the Fed or the federal government could do to break out of this rut, Yellen evaded the question at the Fed’s press conference on Wednesday, saying that she hoped the damaging effects of the recession–like exaggerated long-term unemployment and damaged household credit worthiness–would wane as time passes.