Over the past several years, the Fed has revised its estimate of potential GDP growth downward. Lower potential growth has enormous implications for output, aggregate demand, and revenue generation in our economy. Since 2011 the Fed’s estimate of the potential growth rate has edged down from as high as 2.7% to now only 1.8%,2 with some estimates even lower.3

The impact of slower potential growth Q4 2011 Q4 2014 Q4 2015 Q4 2016 Q4 2012 Q4 2013 San Fran Fed Q4 2017 Sources: Economic projections of the Federal Reserve Board; FRBSF Economic Letter, “What Is the New Normal for U.S. Growth?,” October 11, 2016. THE IMPACT OF SLOWER POTENTIAL GROWTH 1.5% 1.75% 1.0% 1.5% 2.0% 2.5% 3.0% 1.8% 1.8% 2.0% 2.3% 2.0% 2.4% 2.2% 2.5% 2.3% 2.7% 2.4%

We will be watching: In 2018, our current economic expansion is on track to turn 9 years old, making it the second-longest period of growth since World War II. Paradoxically, our long expansion can be partly explained by growth that is broadly in line with potential growth. Real GDP has averaged 2.2%,4 a low growth rate historically, even though it is still slightly higher than the Fed’s estimate of potential. We expect growth to remain elevated above potential and will keep a close eye on the Fed’s estimate of underlying potential growth to see whether actual growth and potential growth are trending together.

Risks to our view: Ironically, one risk to our current expansion could be growth that accelerates sharply ahead of potential. Given currently low productivity, a surge in growth would mean the economy risks overheating, which could cause the Fed to aggressively raise rates. Aggressive rate hike cycles have preceded each of the prior three recessions.

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2 Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, December 2017.
3 FRBSF Economic Letter, “What Is the New Normal for U.S. Growth?,” October 11, 2016.
4 The NBER dates the beginning of the current expansion as Q3 2009. The average was calculated by averaging real GDP %q/q, from Q3 2009 until Q3 2017. NBER, U.S. Bureau of Economic Analysis, as of December 28, 2017.

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