Stanley Fischer: Longer-term challenges for the US economy
Speech by Mr Stanley Fischer, Vice Chair of the Board of Governors of the Federal Reserve
System, at "A Conversation with Stanley Fischer", sponsored by the Council on Foreign
Relations, New York City, 21 November 2016.
* * *
Notwithstanding a number of shocks over the past year, the U.S. economy is performing
reasonably well. Job gains have been robust in recent years, and the unemployment rate has
declined to 4.9 percent, likely close to its long-run sustainable level. After running at a subdued
pace during the first half of the year, gross domestic product growth has picked up in the most
recent data, and inflation has been firming toward the Federal Open Market Committee's 2
1
percent target.
Although the economy has moved back to the vicinity of the Committee's employment and
inflation targets-suggesting that the cyclical drag on the economy has been greatly reduced, if
not largely eliminated-along some dimensions this has not been a happy recovery. Unease with
the economy reflects a number of longer-term challenges, challenges that will require a different
set of policy tools than those used to address nearer-term cyclical shortfalls in growth.
Prominent among these challenges are low equilibrium interest rates and sluggish productivity
growth in the United States and abroad. I will first touch on low interest rates before turning to
productivity. The federal funds rate and policy rates in other advanced economies remain very
low or even negative. Longer-term rates are also low by historical standards, even taking into
account the increase of the past two weeks.
Such low interest rates, together with only tepid growth, suggest that the equilibrium interest rate
-that is, the rate that neither boosts nor slows the economy-has fallen. Why does this matter?
Importantly, low interest rates make the economy more vulnerable to adverse shocks by
constraining the ability of monetary policy to combat recessions using conventional interest rate
policy-because the effective lower bound on the interest rate means that monetary policy has
less room to reduce the interest rate when that becomes necessary. Also, low equilibrium rates
could threaten financial stability by encouraging a reach for yield and compressing net interest
margins, although it is important to point out that so far we have not seen evidence that low rates
have notably increased financial vulnerabilities in the U.S. financial system. More fundamentally,
low equilibrium real rates could signal that the economy's long-run growth prospects are dim.
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Why are interest rates so low? In a speech last month, I identified a number of factors that have
worked to boost saving, depress investment, or both. Among the factors holding down interest
rates is the sluggishness of foreign economic growth. Another is demographics, with saving
being higher as a result of an increase in the average age of the U.S. population. Also,
investment recently has been weaker than might otherwise be expected, perhaps reflecting
uncertainty about longer-run growth prospects, as well as the decline in investment in the energy
sector as a result of the fall in the price of oil. Finally, and most important, weak productivity
growth has likely pushed down interest rates both by lowering investment, as firms lower their
expectations for the marginal return on investment, and by increasing saving, as consumers
lower their expectations for income growth and borrow less and/or save more as a
consequence.
Understanding the recent weakness of productivity growth is central to addressing the longer-run
challenges confronting the economy. Productivity growth over the past decade has been
lackluster by post-World War II standards. Output per hour increased only 1-1/4 percent per
year, on average, from 2006 to 2015, compared with its long-run average of 2-1/2 percent from
1949 to 2005. This halving of productivity growth, if it were to persist, would have wide-ranging
consequences for living standards, wage growth, and economic policy more broadly. A number
of explanations have been offered for the decline in productivity growth, including
mismeasurement in the official statistics, depressed capital investment, and a falloff in business
dynamism, with reality likely reflecting some combination of all of these factors and more.
We should also consider the possibility that weak demand has played a role in holding back
productivity growth, although standard economic textbooks generally trace a path from
productivity growth to demand rather than vice versa. Chair Yellen recently spoke on the
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influence of demand on aggregate supply. In her speech, she reviewed a body of literature that
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suggests that demand conditions can have persistent effects on supply. In most of the
literature, these effects are thought to occur through hysteresis in labor markets. But there are
likely also some channels through which low aggregate demand could affect productivity,
perhaps by lowering research-and-development spending or decreasing the pace of firm
formation and innovation. I believe that the relationship between productivity growth and the
strength of aggregate demand is an area where further research is required.
I will conclude by reiterating one aspect of the low interest rate and low productivity growth
problems that I have mentioned previously-the fact that, for several years, the Fed has been
close to being "the only game in town," as Mohamed El-Erian described it in his recent
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book. But macroeconomic policy does not have to be confined to monetary policy. Certain fiscal
policies, particularly those that increase productivity, can increase the potential of the economy
and help confront some of our longer-term economic challenges. While there is disagreement
about what the most effective policies would be, some combination of improved public
infrastructure, better education, more encouragement for private investment, and more effective
regulation all likely have a role to play in promoting faster growth of productivity and living
standards. By raising equilibrium interest rates, such policies may also reduce the probability that
the economy, and the Federal Reserve, will have to contend more than is necessary with the
effective lower bound on interest rates.
1
Views expressed are mine and are not necessarily those of the Federal Reserve Board or the Federal Open
Market Committee.
2
See Stanley Fischer (2016), "Why Are Interest Rates So Low? Causes and Implications," speech delivered at
the Economic Club of New York, New York, October 17.
3
See Janet L. Yellen (2016), "Macroeconomic Research after the Crisis," speech delivered at "The Elusive 'Great'
Recovery: Causes and Implications for Future Business Cycle Dynamics," 60th annual economic conference,
held at the Federal Reserve Bank of Boston, Boston, October 14.
4
See, for example, Olivier Blanchard, Eugenio Cerutti, and Lawrence Summers (2015), "Inflation and Activity-
Two Explorations and Their Monetary Policy Implications (PDF)," IMF Working Paper WP/15/230 (Washington:
International Monetary Fund, November); and Dave Reifschneider, William Wascher, and David Wilcox (2015),
"Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary
Policy," IMF Economic Review, vol. 63 (March), pp. 71-109.
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See Mohamed A. El-Erian (2016), The Only Game in Town: Central Banks, Instability, and Avoiding the Next
Collapse (New York: Random House).