Is it time for the Fed to accept US growth is just not what it was?
Year after year Federal Reserve policymakers have clung to a belief that the US economy will soon regain its pre-recession stride. And year after year they have been wrong.
They argue gross domestic product is more likely to grow at a 2pc annual rate, rather than 3pc or more, given the retirement of baby boomers and the extent to which the Great Recession discouraged workers and badly damaged industries such as finance and construction.
If they are right, the heyday of booming US productivity might have passed, and the central bank's aggressive monetary policies may be misdirected and possibly even harmful. If the Fed keeps policy too easy for this more muted economy, it could lead to runaway inflation and asset bubbles.
In the five years since the depths of the financial crisis, the Fed has slashed interest rates to near zero and bought more than $3.8 trillion of bonds to spur consumer and business credit and a recovery in employment and economic growth.
"This sense that real GDP growth is going to pick up soon -- I'm very sceptical about that," Jeffrey Lacker, president of the Richmond Federal Reserve Bank, said earlier this month, citing among other things consumers' apprehension about the effects of another deep recession.
"I know it's a popular forecast, but I'm sceptical," said Lacker, who has long opposed the Fed's very easy policies. "I see 2pc growth ahead."
Most of his colleagues at the central bank disagree.
As of September, the Fed's policy-setting Federal Open Market Committee expected about 3pc GDP growth next year, and up to 3.5pc in 2015 as the economy tries to make up for ground lost in the 2007-2009 recession. A string of business activity gauges have beaten expectations recently, providing some evidence of a strengthening outlook over the near term.
"We are seeing continuing positive signs about momentum going forward," John Williams, the president of the San Francisco Fed and a policy centrist, told reporters last week.
But throughout the slow recovery, the Fed has consistently proven to be overly optimistic, regularly ratcheting down forecasts, which even then have been much higher than reality.
In early 2010, for instance, it forecast that GDP would rise 3.5pc to 4.5pc in 2012; by early 2012, the forecast was cut to 2.2pc to 2.7pc. Ultimately, the economy grew just 2pc.
Many economists at the Fed and elsewhere believe a series of headwinds -- from Europe's debt crisis to sharply tighter fiscal policy in Washington -- has prevented as robust a recovery as they had hoped.
Most Fed officials expect the economy to pick up as the latest fiscal drag fades, before settling back as the recovery matures to the 2.2 pc to 2.5 pc range they see as sustainable over the long haul.
"Our hope is that the improvement in real GDP growth that many forecasters had expected to be in progress by now will soon begin and... provide sustained improvement in labour markets," Boston Fed President Eric Rosengren said last week.
In this view, which remains the consensus, many workers who lost their jobs in recent years will ultimately find employment. More jobs mean more income, which in turn means more spending.
In addition, US households have gone a long way in whittling down their debts and domestic energy output is surging, curbing America's dependence on imports and lowering business costs -- two big reasons for optimism.
Even so, the optimists themselves have grown a bit gun shy. "I've seen this movie before," Dennis Lockhart, the Atlanta Fed chief, said at an economic forum in Montgomery, Alabama.
Fed Chairman Ben Bernanke has been peppered with questions on why the central bank has missed the mark time and again.
At a September news conference, he said the economy's potential growth rate has "slowed somewhat, at least temporarily" due to the crisis and recession, acknowledging that the Fed failed to predict a slowdown in labour productivity.
Productivity and the growth of the workforce determine an economy's potential. Growth in the US labour force averaged 1.6pc from 1970 to 2010, but dropped to just 0.9pc last year. The Congressional Budget Office expects the rate to decline to 0.4 pc by the 2020s as baby boomers retire.
It is harder to know what is behind the slowdown in productivity growth, though economists generally point to lower investment in high-tech capital and research and development.
Since 2005, non-farm productivity growth has dropped a full percentage point to 1.9pc; economists at JPMorgan expect it to eventually hit 1.5pc. Given the shrinking workforce, they think the economy's long-run growth potential has slipped to about 1.75pc -- the lowest in the post-war era.
The Fed's muscular monetary policy has aimed to deliver growth of 3pc or more. That is the pace commonly considered necessary to significantly ratchet down unemployment.
But on this front, too, the Fed has been surprised.
The October unemployment rate of 7.3pc is down from a post-recession high of 10pc in 2009 -- all while GDP growth averaged only about 2.3pc.
Booms in finance and construction hiring helped boost growth before the 2007-09 recession. But those sectors have since lagged, undercutting the economy and raising questions over whether they will ever fully bounce back.
Further, the percentage of working-age Americans who either have a job or are looking for one reached a 35-year low in October, suggesting lasting pessimism about job prospects.
"I'm in the camp that the damage done to the US economy was much larger than most people think," said Bluford Putnam, chief economist at futures exchange operator CME Group and a former economist at the New York Federal Reserve Bank.
"Unless Washington does everything right -- and that's just not going to happen -- the US is a 2pc economy now."