Over the past several years, the Fed has revised its estimate of potential GDP growth downward. Lower potential growth has enormous implications for output, aggregate demand, and revenue generation in our economy. Since 2011 the Fed’s estimate of the potential growth rate has edged down from as high as 2.7%4 to now only 1.8%,5 with some estimates even lower.6
We will be watching: Actual growth may vary from the Fed’s economic projections of potential GDP. A 0.5% drop in projected GDP growth over 5 years equates to approximately $580 billion of lost economic activity.7 The Fed’s estimate of potential growth has fallen even more than that, and current growth rates have broadly matched the Fed’s estimate of potential growth.
Risks to our view: Should productivity improve, the Fed may well revise its potential growth estimate higher. This could signal a more aggressive interest rate path for the Fed, and could mean a more rapid rise in interest rates.
4 Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, November 2011.
5 Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, December 2016.
6 “What Is the New Normal for U.S. Growth?,” FRBSF Economic Letter, October 11, 2016.
7 FS Investments calculated the difference of nominal GDP growth of 2.3% over a 5-year period, versus 1.8% GDP growth over a 5-year period.
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