Hicks
The end of year data is giving economy watchers plenty cause for holiday cheer.
Consumer spending remains robust, and the early holiday sales suggests a record year, even after controlling for inflation. That seems reasonable given that household wealth is at a record level and unemployment is lower than it has been since the Nixon administration. Last week’s job reports showed record employment as part of three years of sustained employment gains.
Inflation-adjusted wages have been growing for several months now with the biggest gains accruing the lowest-paid 80% of workers. Credit card debt is back down to 2019 levels, and there is nothing apparent on the consumption side that would risk derailing this period of growth.
Strong demand for goods and services means strong corporate profits, which has resulted in record-high stock market indices. The stock market is a poor predictor of future economic performance, but better returns further boost consumer spending, particularly among retirees.
Business capital investment is strong but not spectacular, suggesting less volatile expectations by firms. Business expansion is broad and sustained since late 2020, but it is not at a feverish level. New business formation has been proceeding at record levels for close to three years now. Here in Indiana, applications for new businesses are up 84% since COVID, with the most recent quarter near the record.
Fueling much of this optimistic behavior is the steadily retreating inflation. We are now 18 months past peak inflation, and the broadest measures of price change have dropped 16 out of the last 18 months. The measure of personal consumption inflation growth is actually negative over the past two quarters. This is caused by the Federal Reserve reducing the money supply, most visibly through increases in their policy interest rates.
We have now been through seven months without a rate increase, and the Fed again held rates steady this week. It now seems almost certain the Fed will begin easing rates within two quarters, and they have indicated that we should expect at least three cuts in 2024. Financial markets are anticipating this, so mortgage interest rates have declined for seven straight weeks. This will improve the home-buying season this spring.
All of this is good news, but I am looking more closely at labor productivity. Typically, as labor markets tighten, productivity growth slows, or even declines. The reason for this is fairly self-evident. When unemployment rates are high, it is the least productive firms that make cuts. This boosts production per worker, since only the strong businesses survive. When unemployment rates are very low, it because of strong demand. This strong demand for goods and services means a number of less productive firms can still hang on. This slows productivity growth.
For the first 18 months after COVID, this pattern almost perfectly repeated itself. Big job losses meant that only the best firms survived, so productivity growth soared. As we got back to normal, we saw productivity growth dip into negative territory as expected. But, for close to two years productivity growth has slowly improved. Last quarter it stood at 2.4% annualized rate. This is good at any time, but when it happens when the unemployment rate is near a 50-year low, it signals something else is happening.
No one is sure about what might be happening to boost worker productivity, but the are several possibilities. First, is the cyclical nature of technology. We can go through long periods of buying and installing new technology without much effect on the productivity data. It took desktop computers almost two decades to really affect overall efficiency. We might just be in a cycle where investments in digital technology for the last decade is boosting our efficiency at making goods and delivering services.
A second feature might be the expansion of remote work. For many occupations, the ability to work from home offers substantial productivity improvements. Randomized control trials from before COVID identified substantially more efficient workplaces when workers could voluntarily remain at home. There is significant evidence that businesses and workers are working out the kinks in technology and processes to make themselves more efficient.
A third aspect of the economy is simple demographic change. Millennials are now the largest generation at work in the economy. These workers are entering the most productive years of their work lives, giving the U.S. a large bump in average worker productivity. This alone is large enough to boost overall economic performance.
Most likely, all of these factors are working to make the current economy grow faster than we’ve seen so far in the 21st century. The blistering pace of GDP growth last quarter, topping 5.2%, suggests this is not a transient effect. Given a smooth patch of economic fundamentals, the U.S. might be heading for a period more reminiscent of the late 1990s than anything we’ve seen since. That would be most welcoming, but there are things that could derail a period of peaceful prosperity.
War and the rumor of war casts a durable shadow on the peaceful production and exchange of goods and services. As bad as war is, it is preferable to a peace that comes from victory by evil. Two major and several smaller wars pit liberal democracies against the purest of evil. Should Ukraine or Israel lose their wars, it would be disastrous for the U.S. economy. And that is if we are fortunate. Evil lurks in Tehran as well as other capitals. A major conflict will derail our economy, but failure in these wars would be worse.
The U.S. has a high debt, and though it has receded in recent quarters, remains uncomfortably high. The U.S. has weathered high debt for a lot longer than most economists thought possible a generation ago. However, higher borrowing costs threaten our ability to spend money where it is needed, and forces difficult spending and tax choices. A remedy to our deficit problem will require substantial political compromise on both spending and taxes. With the incentive structure in Congress fully condemning compromise, we should not expect action anytime soon.
This climate of opposition comes at the behest of voters. We elected these folks they reflect our values or lack thereof. We will pay for their folly, but don’t blame them. We are at fault for electing people to ‘fight’ for us rather than ‘compromise’ for us. Smart, principled compromise is what we need to sustain our growing economy.
Michael J. Hicks is the director of the Center for Business and Economic Research and the George and Frances Ball Distinguished Professor of Economics in the Miller College of Business at Ball State University. Send comments to [email protected].
