10 years in and the economic recovery keeps chugging along

This summer the U.S. economy will achieve a noteworthy milestone: 10 years of growth. According to official GDP reports, our economy has been expanding since the summer of 2009. 

The pace of growth was quite modest for several years after 2009 but has recently picked up. Barring a sharp downturn, the expansion will very likely set the record for the longest in U.S. history.

{mosads}Recent data suggest the economy is enjoying solid momentum after a strong 2018. The first quarter real GDP growth number was 3.2 percent annualized.

The Bureau of Economic Analysis report delivering this good news was the so-called “advance estimate.” It could be revised in two subsequent reports, but the early news is encouraging. 

If you dig into the 3.2-percent number to understand the makeup of this growth, you find that real final demand (GDP less net inventory accumulation) was 1.3 percent. Inventory gains and net exports (exports minus imports) made up the difference. 

Inventory accumulation tends to vary from quarter to quarter, so the top-line GDP number may come in softer in later quarters. Nonetheless, the economy continues to expand, and the preponderance of data suggests continued growth. 

The Federal Open Market Committee (FOMC) — the policy-making body of the Federal Reserve — is intent on sustaining the economy’s expansion. Monetary policy is not the only factor influencing economic performance, but the FOMC’s interest rate policy setting is certainly a major influence. 

The FOMC’s policy rate — the federal funds rate — is currently set at a range of 2.25-2.5 percent. Importantly, the committee has signaled its intent to keep the policy rate at this level as Fed officials monitor how the economy evolves and how various risks play out. 

Fed Chairman Jay Powell has repeatedly characterized the committee’s posture as “patient” and has expressed his and the committee’s confidence that rate policy is appropriate for the time being. 

Because Fed policy has effect with a lag, monetary policy is almost always premised on an outlook. The outlook for the U.S. economy remains positive for this year and next. The Fed does not see a recession on the horizon, and I concur. 

There is very little evidence at this juncture supporting the view that the economy is stalling out. The Fed’s outlook anticipates slowing growth. This downshift of growth is consistent with a view that the long-run potential rate of growth of the U.S. economy is around 2.0 percent. This slowing reflects waning of fiscal stimulus as well as underlying forces such as demographics and uncertain productivity growth.

I can imagine conditions in which the Fed would keep its policy rate “on hold” for quite a while. The key consideration will be the behavior of inflation. Inflation has been running chronically below the FOMC’s target of 2.0 percent over the long run.  

Fed officials would like to see inflation firm up. At the same time, they are closely watching indicators of inflation expectations. This reflects a concern that, after several years of below-target inflation readings, the public and financial market participants could see inflation well below 2.0 percent as here to stay. The Fed fears such a development because, at the onset of a recession, reversing a negative trend would be harder. 

I think the interest rate policy path is very difficult to predict at this juncture. Some FOMC participants have shown one or two more rate increases in their forecasts. At the same time, the committee is currently reviewing its policy operating framework with a particular focus on inflation. 

A new approach being considered would allow inflation to overshoot the 2.0-percent target for a period offsetting a protracted period of inflation below target. This “make up” approach would replace the current “let bygones be bygones” approach. 

{mossecondads}If the FOMC were to move to this policy framework — hardly a foregone conclusion at this point — it’s possible that higher inflation would be tolerated without immediate resort to further rate hikes. 

I can see two circumstances where the FOMC might actually cut the fed funds rate later this year or next. One would be a sharp economic downturn, and the other would be strong and persistent evidence of inflation expectations anchoring at a dangerously low level. 

Neither situation prevails today, so the more likely scenario, as I see it, is rate policy truly “on hold” until something changes materially. 

Central bankers are inclined to worry, but for now, Chairman Powell and his colleagues appear confident in an outlook of continuing moderate growth, healthy employment markets and stable inflation.

Dennis P. Lockhart served as the president of the Federal Reserve Bank of Atlanta from 2007-2017. He is currently a professor of practice at the Sam Nunn School of International Affairs at Georgia Tech.