September 27th, 2014
by Lakshman Achuthan, Co-Founder and Chief Operations Officer of ECRI
In 2011 the Fed published a study aimed at identifying "particular values for output growth and other variables, such that when these values are reached during an expansion, the economy has tended to move into a recession within a fairly short time span."
The study concluded that Gross Domestic Income (GDI) - which, while income-based, is theoretically identical to GDP – “provides a better measure of output growth than GDP,” and identified a two-quarter annualized real GDI growth rate of 2% to be the “stall speed” threshold.
Unlike the Fed, ECRI does not use such model-based forecasting approaches. But the fact remains that this GDI growth measure (see chart) has now stayed below the 2% “stall speed” threshold (red line) for three straight quarters starting in Q4 2013, which is much longer than the duration of the harsh winter weather.
More importantly, please note that it has dipped below 2% four times in the last four years or so, having done so away from recession only once in the previous half-century. This is reminiscent of the fact that Japan – where trend growth is even lower – is now on the cusp of its fourth outright recession since 2008 (see video), validating our “yo-yo years” thesis.
The point is that, since Q1 2012, GDI growth has actually averaged under 2% a year – less than the “stall speed” itself. Also, as we noted last spring, Federal Open Market Committee (FOMC) members regularly submit their projections of key economic indicators, including GDP growth for the “longer run,” representing the values to which it is expected “to converge over time – maybe five or six years – in the absence of further shocks and under appropriate monetary policy.” In view of the repeated cuts to those estimates in recent years, we observed that “it should be no surprise to see trend growth estimates fall below 2% over time” (May 2014).
Sure enough, those estimates were trimmed again last week, with the midpoint of the “central tendency” falling to 2.15%. Thus, the FOMC’s long-term GDP growth estimate, having dropped by half a percentage point in less than three years, is approaching the “stall speed” the Fed itself estimated about three years ago.