America'seconomy

Howstrongisit?
Nov25th2014,20:47byR.A.|LONDON
ACCORDING to new data released today, America's economy grew at a 3.9% annual pace in the third
quarter of this year. That was anupward revision from theadvanceestimate,of3.5%.Itcameontheheels
of a second quarter in which real output expanded at a 4.6% rate. Indeed, infour ofthelast five quarters
GDP has increased by 3.5%or more (and by4.5% ormore intwoofthelast five quarters).TheAmerican
economy hasn't strung together five quarters like that since the late 1990s. Neither is that the only
encouraging indicator. Over the last year employment has grown at the fastest pacesince2006and the
paceofhiringseemstobetrendingupward.
It isso tempting to conclude thatallisatlastwellinAmerica.But isit?Take anotherlook.Realoutputgrew
just 2.4%fromthethird quarter of 2013 tothethirdquarter ofthisyear. That,ofcourse,isdueto thewoeful
firstquarter,inwhich the economyshrankata2.1%annualpaceatleastsome oftherobustnessofrecent
figures is surely attributable to makeup of ground lost in the first three months of the year. The 2.4%
yearonyearrateisentirelyunexceptional,evenbythestandardsofthisrecoveryindeed,itiscloseto bang
on the trend since 2010. Meanwhile, growth in both wages and prices is remarkably weak. Growth in
average weekly earnings has been just 2.8% over the last year: fairly normal for this recovery and well
belowthe ratesin pastexpansions. Meanwhile,theprice indexforpersonalconsumptionexpenditures(the
inflation measure targeted by the Federal Reserve)rosejust 1.5%inthe third quarter, down from a 1.6%
increaseinthesecondquarter.
And this is all occuring, of course, in a world in which the Fed's main policyrate is nearlyzero (while its
balance sheet stands at $4 trillion). Things are clearly still amiss in America when monetary policy can
remain so far from normal while the economy revs up even as inflation and wage growth limp along at
pitifullylowlevels.
Despite the absence of inflationary pressure the Fed is nonetheless preparing to normalise the first rate
hikes could come next year, and possibly as early as the first half of next year if American growth
accelerates. Yet the Fed will surely be keeping an eye on the things to see which of several possible
narrativesmightbestfitthisstrange,strangesetofdatapoints.Whatsortofnarratives?
One would beaneconomyinwhich recentGDPdatapainta misleadinglyrosypictureof things.Fastgrowth
in the last twoquarters could bepart volatility and part arebound from thesnowy startto theyear, inthis
story, and we should anticipate reversion to a slower growth rate more in keepingwiththe signals sent by
prices and wages. This story, though quite plausible, becomes less attractive with each encouraging
datapoint.ThissuggeststheFedshouldbewatchingcloselyforanysignofagrowthslippage.
Asecond might bean economy thathasgottenquite lucky, in its way. The Americaneconomyis relatively
closed, andso agrowthslowdowndoesn't hurtgrowthverymuchviaatradechannelbutcanhelpgrowthif
resulting weak inflation is good for consumers. It might be the case that the economy is fundamentally
unchanged from whereit was a yearor twoago,buthasreceivedaboostfromthefallingcostofpetroland
othercommodities (andperhaps also from the abatementofgovernment deficit reduction).Inthiscasethe

Fed shouldagain beon the lookout, but for indicationsthat disinflationarytailwindsare flagging orthatthe
economyisapproachingcapacity,eitherofwhichtrendscouldnudgeupinflation.
A third might be a secular stagnation world. The Fedhasfinally succeededin getting growth going, but it
mostlikelyhasonlymanagedthisbycreatingdangerousandunsustainableincreasesinassetprices.In this
story theFedfacesanastychoice:totrytoidentify the mostworryingsortsofexcessandreintheminat the
costofgrowth,ortotolerategrowingfinancialinstabilityinhopesthefalloutisrelativelyharmless.
Afourthmightbe a world in whichunderlyingproductivity potentialisfinallygrowingnicely,thanksinpart to
information technology advances, new digital business models, andthetremendous boost from American
energy production. These trends are allowing growth in output to run ahead ofgrowth in employment. Yet
technology is also keeping a lid on wage growth, thanks to possibilities for automation and innovative
business models that tap into new sources of labour supply. In this world, the Fedneed notworry much
about overshooting indeed, the hotter it runs the economy the morequickly new costsaving technologies
willbeexploited.
Any of these might be true. What the Fed ought also to remember is that it remains stuck within one
wellestablished narrative:that of the zero interest rate world. Inthatworld,growthcanchugalongnicelyin
the absence of nasty surprises, but quickly falterswhenthey arise. Inthatworldinflation expectations can
be nudged upward by expasionary policy or rising commodity prices but always plateau and eventually
beginfallingback toward zero. Andinthatworldthetimeatwhichalowinflationeconomyisexpectedtobe
strongenoughtohandlesustainedinterestrateincreasesalwaysloomsjustoverthehorizon.
The American recovery has been looking impressive lately, but that isnothingtotake forgranted,notwhile
interestratesandinflationaresolowandtherestoftheworldeconomysoshaky.