Fed's Vice Chairman, Stanley Fischer, States the Obvious and Creates a Buzz

Commentary by Bob McTeer

Source: Forbes

In a speech in Sweden, apparently only the second one since becoming Vice Chairman of the Fed’s Board of Governors, Mr. Fischer said that both the U.S. and the global recoveries have been disappointing. Well, duh!

That load of insight had people talking all day today on financial TV, including me on CNBC.

I take the ‘duh’ back. I’ve had enough experience to know how little control one has over how the press spins ones words. I’m pretty sure he didn’t claim to be original in those insights.

The press coverage over a statement so obvious does demonstrate one thing, at least: diminishing marginal utility. Mr. Fischer’s relative silence since becoming number two on the Board of Governors has made his words more valuable at the margin. He hasn’t taken us very far out the curve of diminishing marginal utility; so his words carry more weight.

The Fed’s job, as they probably still see it, is to conduct monetary policy to help the economy reach its growth potential without surpassing it and creating too much inflation. What Mr. Fischer was talking about was that potential. If the economy is capable of growing three to three and a half percent per year without accelerating inflation, then the potential growth rate is three to three and a half percent. That’s pretty much what it was assumed to be in my day, although it was probably a bit higher during the second half of the 1990’s when productivity growth accelerated. Faster productivity growth enabled the economy to have faster output and employment growth with less inflation and unemployment. It made everything better.

As Mr. Fischer noted, output and income growth depends largely on labor productivity (output per hour worked) and the supply of labor for production. In other words, the number of workers and their productivity.

We are all vaguely aware of the slowdown in productivity growth in recent years, but I was still surprised at how much it had slowed down. When you look it up at the Bureau of Labor Statistics, the first thing you learn is that productivity for all businesses increased at a 2.5 percent rate in the second quarter of this year after falling 4.5 at an annual rate during the first quarter. You heard that right: productivity fell at a 4.5 percent rate in the first quarter when production declined much faster than hours worked.

The second thing you learn, when you look at the table, is that productivity growth was almost nonexistent during the previous three years: 2011 (+0.1%), 2012 (+1.0%), and 2013 (+0.9%). Okay, the way I figure it, productivity grew 2 percent in three years, or two-thirds of one percent per year. Then it declined to negative in the first half of 2014. The numbers, of course, are less-bad in the manufacturing sector.

This stagnate productivity growth means that a labor force of a give size produces hardly any more goods and services from one year to the next. Well, what about the size of the labor force? It’s been shrinking. The labor force participation rate—the people considered to be in the labor force who have jobs—was down to 62.9 percent in July. That is a 36 year low—not a low just since the financial crisis and recession. The downtrend in the size of the labor force as been going on for 36 years, and only accelerated lately.

Definitions of the labor force and whether a given person is in or out of it make the labor force participation rate a bit messy. A cruder, but simpler number is the employment/population ratio, which was only 59 percent in July. In some recent months that number was the lowest ever recorded.

We all know that unemployment is a waste. It keeps us from operating at full potential. But so are labor force dropouts, for whatever reason. Relative to our population, fewer and fewer people are working, producing goods and services. As Senator Gramm from Texas used to say: we have more and more people riding the wagon and fewer and fewer people pulling in the wagon. So, yes, our potential growth has been compromised; so policies to reach our potential will have to take that into account.

On CNBC today, I emphasized the above factors. The other guest in the segment wanted it clear that some of the unemployment and underemployment and the dropouts resulted from cyclical factors rather than secular factors and could be reduced with appropriate policies. Of course, that’s right. But I’m afraid that after our policy makers have done all they can do, we may still be disappointed in our slow growth economy.

I don’t have good answers. Conduct proper policies and hope that takes care of more of the problem than I suspect. Since we are apparently not quite having babies at the replacement rate of 2.1 per couple, I think there is a role for—dare I say it—immigration reform. We need more younger workers helping pull the wagon, particularly educated and skilled younger workers like those we graduate from our universities and refuse to let stay and work here.

While the politicians delay dealing with the stickier issues of immigration reform, surely they could get together on abolishing the limits on H1b visas for young educated foreign workers.