We have argued before that structural forces have fostered a low-growth and low interest rate environment in the post-crisis period. Yet lower potential growth doesn’t imply the current U.S. economic expansion, one of the longest in the post-war period, is fragile or about to end.
That’s why keeping economic cycles in context matters. We have created an interactive tool to do just that. All economic cycles share a similar trajectory. From a late-cycle inflationary peak, a recession drives activity to a trough. Economic activity falls below potential. Slack opens up, and a recovery begins. But growth needs to be faster than potential to reduce the slack created in the downturn. As spare capacity is used up, we enter a reflationary period—the sweet spot of the cycle. We then transition into a late-cycle period leading to a new peak. These milestones are common to all cycles, but the time between them varies depending on the expansion’s vigor.
The longer it takes to absorb economy-wide slack, the longer the cycle should run. This means that economic slack is arguably a better way to benchmark where we are in the cycle than simply looking at the time elapsed since the last recession.
The BlackRock Investment Institute, with the help of my colleague Joshua McCallum, produced a series of charts for our May 2017 Global macro outlook to better understand U.S. economic cycles back to 1953—based on their highs and lows and the path trod in between rather than just across time. Some of this work is inspired by economists James Stock and Mark Watson who proposed such a method for better understanding inflation across cycles in a paper at the Kansas City Fed’s 2010 Jackson Hole symposium.
The first interactive chart shows U.S. gross domestic product cycles, with each dot on a line depicting a calendar quarter. What stands out? This looks like a completely normal cycle and is tracking the previous two cycles closely. The interactive allows the user to compare how these cycle charts look across time and across cycle stages to help intuitively appreciate the difference between these two perspectives.
We believe lower growth rates in this recovery imply that slack is being eroded much more slowly relative to previous cycles—especially given the sheer spare capacity created after such a shock as the 2007–08 financial crisis.
Economy-wide measures suggest that slack hasn’t been eliminated by now unless one makes big assumptions about the recession having been less severe or potential growth being well below 2%. We see potential growth near 2%.
Much of the debate about slack, the drop in unemployment to 16-year lows and wage gains goes to the heart of the Phillips Curve—a model developed in 1950s by New Zealand economist William Phillips to determine the inverse relationship between the unemployment rate and inflation. It remains a crux of economics today. For a given level of inflation expectations, labor market tightness should imply wage pressures, as workers demand higher compensation, and broader pressures on inflation.
The conventional wisdom in this cycle’s most notable characteristic has been tepid wage growth. Yet when looking at a cycle comparison, wage growth does not seem out of line with the experience of the past few decades.
That suggests the Phillips curve hasn’t necessarily flattened as much as some assume now—that is, wages might not be less responsive to the tightening labor market. Wage growth stalling here would suggest a structural shift making this cycle truly distinct from all the others in the post-war period.
We find these cycle charts compelling in understanding where we are now: very far along if judged purely by time, yet with much more room to run when slack is taken into account. The economy’s snail’s pace of growth—and snail’s pace reduction of slack relative to the past—suggests that this cycle’s remaining lifespan can be measured in years, not quarters, we believe.
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