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Be careful of "babble talk that sounds totally real"
(April 15, 2015)

Once again, I made the mistake of turning up the sound during a show on one of the more popular financial news networks when I heard a well-regarded economist say something that sounded plausible but was nothing more than "babble." I say this because as I watched, I was reminded of a Dilbert cartoon by Scott Adams dated March 26, 2015 in which a bald guy, who babbled, was promoted to chief economist because he sounded smart. Of course, being bald and an economist, this particular cartoon hit close to home. And I have to admit that economic analysis relies on data that has its issues, causing some to confuse it with babble. Indeed, data revisions have made me look like a babbler from time to time. But what I heard from this gentleman even sounded like babble to me. I won't keep you in suspense any longer. One of the hosts of the show suggested that the U.S. economy was finally doing better. He disagreed. He said the economy still had not recovered from the last recession because real gross domestic product (GDP) had not returned to the level it would have been at if we didn't have the last recession.

What did he mean by this statement? I'm sure he didn't mean exactly what he said. If the definition of a recovery was that real GDP had to get back to the level it would have been at without a recession, then the economy by definition would never recover. There must be more to it than that.

Maybe he meant that real GDP had not yet recovered all that was lost during the last recession. However, I doubt this is what he had in mind. After all, real GDP in the fourth quarter of 2014 as estimated by the Bureau of Economic Analysis was 8.7 percent above its previous peak just prior to the start of the last recession. The bad news is that it is only 8.7 percent higher after five and a half years of real GDP trending upward. That being said, there was considerable improvement needed just to "recover" from the last recession because it was so long and severe—the longest and most severe in the post-WWII era.

What I think he had in mind was that actual real GDP in the fourth quarter of 2014, although higher than its peak prior to the last recession, was still below some measure of potential real GDP. Recall that potential real GDP is a measure of real output if the economy always operates exactly at full employment; that is, never a recession but also never a recovery. Of course, there are several assumptions underlying measures of potential GDP, including a definition of full employment. The most often cited measure of potential real GDP is the one derived by the Congressional Budget Office. As shown in Chart 1, the most recent estimate of real GDP (the fourth quarter of 2014) was still below the CBO's estimate of potential. Based on this gap, one could argue that the U.S. economy has not yet fully recovered.

chart 1

Of course, this conclusion is based on a measure that possibly overstates the U.S. economy's potential; not so much in the future as in the past. In particular, it may be that CBO's estimate of potential real GDP in the previous decade was too high and that actual GDP during this earlier period exceeded potential by more than estimated by CBO. For example, an alternative to the CBO's estimate is a "Trendline" based on a least square regression (see Chart 1). This estimate of potential suggests that it was the excesses from 1999 to 2007 that was out of sync with the trend more so than the last recession and the current slow-motion recovery. After all, some of the upside in real output during that period was due to the artificial boom in housing, which was proven to be unsustainable. Moreover, the unemployment rate fell to a low of 4.4 percent in late 2006 and again in early 2007, which very likely was well beyond the full-employment measure of unemployment.

If I had been asked how the economy was doing, I would have been a bit more upbeat about the recovery but somewhat more cautionary about any further expansion. Now some of you may think that this is babble speak. If so, I only hope I can convince you otherwise. One the first score, the rate of real GDP growth over the first five years of the current expansion averaged a mere 2.2 percent at an annual rate, well below the average for the first five years of previous expansions. Yet it was fast enough to cut the unemployment rate over the same period to a level last month that was nearly half of where it was. Clearly, the U.S. economy has grown at a faster pace than its potential for this to happen. From that perspective, the economy has performed quite well.

With regard to the future, real GDP growth is expected to accelerate somewhat this year compared with last year. But even if it does not, the pace is very likely to be faster than the economy's potential. As a result, the unemployment rate will continue to fall, pushing the U.S. economy above its full employment level. And as always, this will lead to excesses that will threaten the expansion. In other words, it is not the pace of the expansion alone that matters but the economy's growth rate relative to its potential. Hence, the key is to determine a reasonable estimate of the economy's potential. Whoops! I sound like the bald guy again. period

Daniel E. Laufenberg, Ph.D.

April 15, 2015


For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

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The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

2015 Commentary

Be careful of "babble talk that sounds totally real" (Current Article)
- - -April 15, 2015

The dollar, oil and the Fed
-- January 16, 2015

2014 Commentary

Press Conference in honor of U.S. Opens -- June 20, 2014

Implications of an even weaker First Quarter -- March 29, 2014

Invasion! -- March 3, 2014

2013 Commentary

Furloughed! -- October 25, 2013

Doomsday forecasts: Honest people can disagree -- April 26, 2013

Making sense of the February jobs report -- March 10, 2013

Growth gyrations continue
-- January 28, 2013

2012 Commentary

Optimism, not irrational exuberance -- October 15, 2012

Disappointing but far from disastrous -- July 31, 2012

Assessing the recent weak economic data -- June 8, 2012

Consensus too pessimistic about everything -- April 16, 2012

Risks to the forecast -- March 7, 2012

A good finish to 2011 but still not good enough -- January 27, 2012

2011 Commentary

More evidence of a strong finish -- December 22, 2011

Finishing Strong -- October 14, 2011

Living in interesting times -- September 8, 2011

A not so pleasant surprise! -- September 2, 2011

Surprise! -- August 16, 2011

Debt ceiling politics -- July 25, 2011

Q2 growth: Another disappointment likely -- July 14, 2011

Interpreting the ISM manufacturing index and the employment situation report for May -- June 4, 2011

A slower start to 2011 than anticipated earlier -- April 14, 2011

Is the dollar's status as the reserve currency at risk? -- March 21, 2011

More trouble in the Middle East -- February 26, 2011

Searching for the next debt crisis -- January 13, 2011

2010 Commentary

What's going on? -- October 15, 2010

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