From the Economist's Free Exchange blog:
America’s economy is growing at an unimpressive rate. It may not be able to go much faster
WHEN the American economy emerged from recession three years ago, forecasters fell into two broad camps. Optimists reckoned brisk growth would quickly return the economy to its long-term potential level of output, the maximum sustainable GDP that could be achieved with the capital and labour on hand. That would pull down unemployment and prop up inflation. Pessimists, however, predicted sluggish growth, persistently high unemployment and inflation that would slip ever lower as a result of unused capacity in the economy.HT: Abnormal Returns
What has actually happened since then has been a mixture of the two. Unemployment and inflation have moved in the directions that optimists expected. Since peaking at 10% in late 2009, the jobless rate has now fallen by nearly two percentage points. Core inflation, which excludes food and energy, dipped below 1% in 2010 but is now above 2%. Yet economic growth has averaged 2.5%, a rate more typical of the economy at full employment rather than when recovering from a deep bust.
Economists advance several explanations for this dichotomy. The drop in unemployment may simply be mechanical, a snapback after employers fired workers too indiscriminately during the recession. Inflation has been underpinned by the indirect effects of higher commodity prices, rising rents and the influence of stable inflation expectations on prices and wages. Optimists say that GDP may be revised up later.
But there is another, more troubling possibility: the crisis may have permanently dented America’s productive capacity. If so, the “output gap” between the economy’s current level of production and its potential level is much smaller than expected. Unemployment has fallen because there are fewer people available to work. Inflation is stable because there is less idle capacity to restrain prices. This would be bad news all round. America would be permanently poorer than would otherwise have been the case. The Federal Reserve would have less room to ease policy before inflation revives. More of the budget deficit would be structural, rather than the temporary result of a depressed economy....MORE