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An Unsung Economic Stat Illustrates Yellen’s Challenge

Michael Santoli

Before she’s confirmed as the 15th chairman of the Federal Reserve, Janet Yellen will almost certainly have access restored to the heavy flow of high-frequency, up-to-date government economic data that is now stilled by the federal shutdown.

Yet while economists and investors wait for the output of official employment, production and inflation numbers to resume, there is one little-noticed, slower-moving statistic that nicely illustrates Yellen’s long-term challenge in trying to foster a peppier U.S. economy.

With the help of the Fed’s aggressive easy-money efforts, the slow but consistent recovery has pushed several broad measures of economic performance to new highs. Total real gross domestic product – the size of the U.S. economic pie produced annually – has climbed to successive record levels since 2011. The stock market, corporate profits and household net worth have also posted all-time highs this year.

Yet a key measure of how well Americans are doing is running well behind the pre-crisis peak: real per capita GDP, or annual economic output divided by the U.S. population. As the chart above shows, the average size of each American's share of economic activity and opportunity has been rising since 2009, but hasn’t recouped what was lost in the downturn.

It is somewhat related to the other nagging trend weighing on the typical household: Real median income has barely stabilized lately after sliding steeply in recent years.

The lag in per capita GDP arises from the combination of disappointing growth rates of below 3% for most of the past few years, and continued U.S. population growth that's somewhat brisker than in most mature economies. The country's population has grown at a nearly 0.8% annual pace since 2010 and should stay in that general range for some time.

In most respects, a growing population -- through net immigration and higher birth rates than in Western Europe or Japan – is a key advantage over other large developed economies. It's a tailwind for consumer demand and labor-force growth, and slightly mitigates an aging population. If the population were not growing, then the U.S. economy would likely be expanding even more anemically.

Yet when the economy is expanding at an inflation-adjusted rate of 2% to 3% a year, it has a hard time outpacing population expansion of nearly 1% by enough to enlarge each person’s average piece of the economic pie.

This suggests, among other things, that the acute income-inequality spread in the U.S. won’t likely abate or reverse soon. And the contentious debates on how to allocate taxes and government benefits (byproducts of the demographic and inequality trends) probably will be with us for a long time to come.

This doesn’t much change the underlying mission that Yellen is to undertake -- stoking credit creation, hiring, and consumer and business demand with accommodative monetary policies. Yet it frames her challenge in a way that goes beyond the relatively simple jobless-rate and inflation thresholds the Fed has propagated as “thresholds” for when it might consider lifting short-term interest rates.

Yellen is already viewed as being more focused on supporting employment growth than preemptively heading off inflation pressures. And much about America’s demographics will likely support this orientation.

As recent experience shows, the Fed can't easily spark a rapid acceleration or sustained surge in economic growth. But the hope is that the central bank can stretch out the expansion over a longer period of time, in part by giving clear guidance about long-term policy intentions, and giving per-capita measures time to "catch up." The Fed in a sense manipulates the time of a cycle more than its strength, in this view.

And if, over such a stretch, the Fed "gets lucky" and a capital-spending or innovation boom takes hold as in the late '90s, all the better - and Yellen could adjust accordingly.

Even though the population is growing at a slow-and-steady pace, the net increase in working-age Americans will be quite low for some time to come.

Harley Bassman, an interest-rate trading strategist at Credit Suisse, points out, “The entry of Echo Boomers into the labor force will not overwhelm Baby Boomer retirements for 15 years. That, in conjunction with a low level of productivity [growth] and a contained inflation rate will make it hard for nominal ten-year interest rates to exceed 5.5% for the next decade.”

(Those same trends, incidentally, could also drop the unemployment rate below the 6.5% Fed threshold more quickly than expected, given slower productivity growth boosting hiring as the labor participation rate remains weak. This could present Yellen with a situation in which nice improvement in measured unemployment still co-exists with subpar income growth.)

As Bassman lays out in an entry in Business Insider’s “Most Important Charts in the World” feature, the average monthly rise in people entering the labor force will trend from the current 60,000 pace down to near zero in 2020, without rebounding much until 2030.

So drags on both growth potential and inflation should keep bond yields below what came to be considered the “normal” range in the ‘80s and ‘90s, while leaving Yellen and her colleagues to figure out exactly how aggressive they might have to be in countering demographic tectonics in an income-short economy.