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posted on 19 March 2016

Monetary Policy And The New Normal

from the Philadelphia Fed

-- this post authored by Michael Dotsey

Is the economy in for a prolonged spell of slow growth, as some believe, or a burst of innovation and productivity? In either event, policymakers must pay close attention to productivity trends. There is growing debate regarding whether the U.S. economy has entered a period of long-run, or secular, stagnation.

The Great Recession has certainly increased interest in that discussion. While the onset of the stagnation is said to predate the Great Recession by 35 years, labor productivity has slowed further since 2010. History shows that recessions, even the Great Depression, have not generally had any effect on long-run economic growth.

However, one still wonders whether this latest recession's legacy will exacerbate any fundamental decline in U.S. economic growth, perhaps through a lingering deterioration in job skills arising from historically high long-term unemployment or through inefficiencies from overregulation in response to the financial crisis. Whether we will see stagnation or a rebirth of productivity obviously has serious implications for Americans' standard of living. But as I will show, it also has important implications for how monetary policy may need to adjust.

What historically matters for the economy in the long run are changes in the trend growth rate of labor productivity, which measures how much the economy produces per hour worked. Indeed, as Paul Krugman famously said, even though productivity isn't everything, in the long run it is almost everything. The reason is that productivity growth leads directly to greater efficiency in production and hence to greater output per hour. The greater productivity of labor in turn results in higher wages, income, and consumption.

[click on image to continue reading]

Source: https://www.philadelphiafed.org/-/media/ research-and-data/ publications/ economic-insights/ 2016/ q1/ eiq116_monetary_policy_and_the_new_normal.pdf? la=en

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