Last week, Professor Jeremy Siegel and I chatted with Jan Hatzius, Chief Economist at Goldman Sachs, to discuss his thoughts on the state of the U.S. economy, Fed policy action and long-term growth forecasts.
Highlights from the Fed Policy Meeting
The Federal Reserve (Fed) conducted its policy meeting last week and held a press conference shortly after. Both Professor Siegel and Hatzius noted that the members of the Federal Open Market Committee (FOMC) brought down their estimates for what the most appropriate monetary policy rates should be—commonly known as the “dot plots.”
They both believe these downgrades were particularly meaningful. Hatzius noted that in March 2015 three people penciled in zero or one hike this year, and that number has now increased to seven. Hatzius believes—somewhat speculatively but also critically—that one of these seven was Fed chairman Janet Yellen. As a result, Hatzius’ team at Goldman pushed back its call for the first Fed rate hike to December 2015 (from September).
Siegel pointed out that Hatzius’ forecast is counter to the majority of the committee. Yes, there were seven dots indicating one hike as most appropriate policy—up from three dots in March—but there were also 10 members indicating two to three rate hikes as the appropriate policy.
Position on the Long Run, New Neutral 2% Not 4%?
While the Fed prescribes a long-run tendency for a neutral Federal Funds Rate to be closer to 4%, a number of analysts, including Bill Gross, expect a new neutral Fed Funds Rate to be 2%. The lower neutral policy rate coincides with slower growth potential in the economy.
Hatzius disagrees with the new normal theory and sides with the Fed in having higher expectations for the neutral target rate. While slower population and productivity growth can lead to generally lower economic growth, Hatzius does not believe it should slash 1.5% off of nominal growth figures. He expects longer-term growth to be closer to historical averages, disagreeing with predictions for growth of just 2%.
Productivity Paradox and Potential Growth
Within the last decade, we have experienced a disappointing productivity environment—similar to that witnessed in both the mid-1970s and mid-’90s, when the measure of productivity growth trended around 1.5%.
Hatzius believes the current environment does not look like one where productivity has slowed as much as the gross domestic product (GDP) numbers imply. He has difficulty believing that “true” productivity has slowed materially considering that profit margins, inflation, equity valuations and the performance of the Information Technology sector have all been stellar. Instead, poor productivity growth may just be a function of mismeasuring productivity and other economic numbers.
It has become increasingly difficult to quantify technological progress. For perspective, in late the ’90s, the center of gravity for productivity growth was faster processors and greater memory capacity in computer hardware. Statisticians translated that into large quality adjustments through widespread price declines and thus large increases in technology output. The tech sector, including both hardware and software sectors, experienced a price drop of 7% to 8% in both the late ’80s and ’90s. In contrast, today, it is much tougher to measure software and digital output, and the price declines have barely budged, despite likely increases in the quality of software.