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US economic cycle: a happy birthday?

The current phase of expansion in the US economy has just entered into its 10th year. Is this a time to celebrate or to worry? Is the end nigh?

The current phase of expansion in the US economy has just entered into its 10th year. Is this a time to celebrate or to worry? Is the end nigh?

This article lays out some of the basic ideas of the economic cycle in the form of charts with strong references to the negative reply of the Federal Reserve of San Francisco (Fed) to the question “Will the Economic Recovery Die of Old Age?” in 2016.

"Like Peter Pan, recoveries appear to never grow old."

Glenn D. Rudebusch, Will the Economic Recovery Die of Old Age?

A long phase of expansion

Let us now analyse some objective figures on the length of the current phase of expansion. In September 2010, the National Bureau of Economic Research (NBER) determined that the Great Recession, which had been caused by the subprime crisis, had in fact ended in June 2009.

Exhibit 1: Year-on-year GDP growth (%) and recessions

US economic expansion

Source: NBER, BEA, BNP Paribas Asset Management, as of 28/06/2018

The NBER dates economic cycles based on a rigorous procedure that goes beyond the mere standard according to which two consecutive quarters of contraction in GDP mean that an economy is in a recession.

Exhibit 2: History of US recessions

The chart below depicts the recessions that the US economy has experienced since the mid-1800s. The width of each bar shows how long each recession lasted rather than its intensity. It is easy to see the transition from an industrial economy, in which phases of expansion and recession come in rapid succession, reflecting the cyclical character of manufacturing activity, to a more services-based economy,  by which is less cyclical by nature. There are, of course, other factors to consider that extend beyond today's topic.US economic expansion

Source: NBER, BEA, BNP Paribas Asset Management, as of 28/06/2018

The expansion since July 2009 is the second-longest. It has now lasted for 108 months, assuming that activity continued to grow in the first quarter of 2018, which should be a safe assumption, based on available indicators.

Exhibit 3: Duration of expansions from the end of the previous recession

US economic expansion

The quarter in which the recovery began (I, II, III or IV) are shown in brackets

Source: NBER, BEA, BNP Paribas Asset Management, as of 28/06/2018

The only period with a longer expansion lasted 120 months, occuring between April 1991 and March 2001.

Economists at international organisations, banks and US institutions are not forecasting any recession in the short term. The current expansion seems to have a good chance of celebrating its 10th anniversary next summer and to come close to, or actually break, the current record.

Time will tell whether this optimism is justified, but, without giving into extrapolations, here are some things to keep in mind on this expansion. We believe their possibility for analysis is more interesting than the mere observation that the expansion is continuing.

Atypical growth: weaker and slower

1. A weaker rate

Growth has been less robust than in previous expansions since the Second World War. The growth rate thus far is almost half as much as the average of past expansions.

The chart below shows cumulative growth throughout the expansion over the last four phases (November 1982 to July 1990, March 1991 to March 2001, November 2001 to December 2007, and June 2009 to the present day). Each is stated by the year when it began.

Exhibit 4: Cumulated GDP growth since trough (%)

US economic expansion

Source: NBER, BEA, BNP Paribas Asset Management, as of 28/06/2018

2. A slower rate

It took time for the economy to revert to its ‘natural’ growth trajectory as represented by potential growth. It also seems that this growth path is lower than suggested by previous estimates.

The chart below presents the data in logarithmic form, which makes it easier to compare rising orders of magnitude visually over time. It shows that economic activity did indeed decline sharply during the Great Recession of 2008-2009, but by no more than during the recession of the early 1980s, and that the potential trend shifted late in the review period

Exhibit 5: Real GDP: actual and potential (logarithmic scale)

US economic expansion

Source: FRED, CBO, BNP Paribas Asset Management, as of 28/06/2018

The chart below takes a shorter timeframe and thus depicts the magnitudes directly in billions of US dollars without creating visual distortions. This approach confirms that the return to potential growth has taken several years, even though this trend has been revised downward.

Exhibit 6: Actual and potential GDP (in billions USD, 2009)

US economic expansion

Source: FRED, BNP Paribas Asset Management, as of 28/06/2018

These Congressional Budget Office (CBO) calculations illustrate one of the many difficulties that have faced the US Federal Reserve and most major central banks in recent years. Making monetary policy decisions requires determining, in one way or another, how an economy evolves with regard to its capacity.

The Taylor rule formalises this approach by expressing the key interest rate as a function of the difference between inflation and the inflation target and the difference between GDP and potential GDP. This is not just an economic theory applicable to all developed economies[1], it is also a way to model the Fed’s dual inflation-jobs mandate. For, in an alternative version of the Taylor rule, it is possible to substitute the difference vs. the natural rate of unemployment for the difference vs. potential.

Exhibit 7: Trend in the fed funds target rate and the rate suggested by the Taylor rule, in %

US economic expansion

Source: Bloomberg, BNP Paribas Asset Management, as of 28/06/2018

Over the past few years, a literal reading of the Taylor rule would have led the Fed to raise its key rates far earlier and by far more.

Central banks are (fortunately) pragmatic

In dealing with uncertainties surrounding potential growth and the ‘natural’ rate of growth, Fed chairs Ben Bernanke and, even more so, Janet Yellen opted for pragmatism and probably worked to prolong the expansion. With the approach consisting in regarding the inflation target as ‘symmetric’, Jerome Powell, who took over at the helm of the Fed in February, is following in their footsteps.

[1] See, for example, the findings of this study by the Bank of France which shows the limits of the Taylor rule

To read more content written by Nathalie Benatia, click here.

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