US Economic Data Beats Expectations: Is Powell's "Greenspan Moment" Coming?

Recently, the macroeconomic data in the United States has been positive, but in this situation, the labor market is also performing well, and inflation is declining. However, former Federal Reserve economist Claudia Sahm wrote that this scene is reminiscent of the mid-1990s economic situation. When faced with such above-trend economic growth, then Federal Reserve Chairman Greenspan wisely chose to pause rate hikes. Now, Powell is also facing a decision.

In a speech at the New York Economic Club last week, Powell said that the US economy is doing well, which may be the most optimistic statement he has made in over two years. Analysts believe that the rate hike plan for November has been shelved, and there may also be a continued pause in rate hikes in December.

Economic growth is one of the warning signs for the Federal Reserve. Powell expressed concerns last week, saying, "To sustainably return to the 2% inflation target, it may require a period of below-trend economic growth and further weakening of the labor market."

Powell also stated, "We are paying attention to recent data that show resilience in economic growth and labor demand. If there is more evidence that economic growth continues to be above trend or that labor market tightness is no longer easing, this could increase the risk of worsening inflation progress and may lead to further tightening of monetary policy."

In addition to Powell, other Fed officials have also frequently expressed concerns about "strong economic growth." At the September interest rate meeting, the Fed raised its forecast for US GDP growth this year and lowered its forecast for next year. Better-than-expected economic data strengthened the Fed's strategy of "maintaining high interest rates for a longer period of time."

Sahm said that theoretically, both the Phillips curve and the Taylor rule support the Fed's current operations. When economic growth is above trend, it shows that strong demand is unsustainable. Assuming that supply continues to fall short of demand, it will push up inflation, making it more complicated to combat inflation.

She believes that the danger of the Fed raising interest rates in a situation where economic growth is above trend is that the current "trend" is still unclear, that is, potential GDP growth. If the "trend" is higher than the Fed's estimate, then the Fed may react excessively to high GDP growth and over-tighten. Especially in the current situation of the US economy, it is still chaotic and it is difficult to determine what the "trend" is.

Looking back at history, the recovery period after the 2008 financial crisis and the second half of the 1990s are two comparable periods because in these two periods, the magnitude of the market's understanding of trend growth changes was both fast and sharp.

In 2013, after the financial crisis, the Congressional Budget Office estimated that the average potential GDP growth rate in the United States from 2012 to 2019 was 2.1%. However, by 2019, the potential GDP growth rate for the same period had dropped significantly to 1.6% compared to the 2013 forecast. This means that if real GDP is to double, it will take about 45 years instead of 34 years. This change occurred in just six years. This trend is also confirmed in the Federal Reserve's economic outlook summary for the same period. At the end of 2011, Fed officials projected a long-term growth rate of 2.4% to 2.7%. By the end of 2019, the growth range had slipped to 1.8% to 2.0%.

Therefore, Sahm believes that this historical trend of lowering growth expectations in a short period of time should serve as a warning for the present. Of course, attempting to quantify and predict growth rates is a common practice, and the models and data support the predicted results. However, caution should be exercised when using growth forecasts to make monetary policy decisions.

In the mid to late 1990s, the situation was completely different. It can now be seen that economic growth at that time exceeded initial expectations, and the growth rate was continuously revised upward, indicating that growth could be sustained without bringing about high inflation risks.

But at that time, this was not clear. The decision-making logic of the Federal Reserve led by Greenspan was the same as it is now, that is, considering raising interest rates when economic growth exceeds the trend level. At least in the mid-1990s, Greenspan wisely judged that the economy still had room for growth compared to expectations, and ultimately GDP did continue to grow without triggering inflation.

In his book "Monetary Policy in the 21st Century," Bernanke stated, "At that time, the economy was growing solidly, with a growth rate of 3% in the first half of 1996 and an unemployment rate of only 5.5%, lower than the Fed officials' expectations. According to the logic of the Phillips curve, inflation should have taken off at this time, and interest rate hikes should have started soon. But Greenspan was uncertain about this and took a reserved attitude. At that time, he developed a set of views to explain why wages and prices could still maintain moderate growth in the case of economic expansion and labor shortages. What he foresaw was the acceleration of technological change."

At that time, Greenspan did not raise interest rates at the Fed because he foresaw that the improvement in productivity was not included in the data used to predict the growth rate. Sahm believes that although Greenspan did raise interest rates six months later, the decision not to raise interest rates in advance when the economy was above the growth trend is valuable today. However, it should be clear that the current economic situation is completely different from that of 1996. The so-called "Greenspan moment" is just to illustrate the need to remain vigilant about expectations of economic growth and early economic data.

Sahm believes that monetary policy and macroeconomic expectations are extremely complex and cannot simply rely on past economic relationships as models. Currently, economic recovery in the United States is uneven across regions. Although the nationwide unemployment rate has been at a historically low level of 3.5% for over a year, the unemployment rate in some areas is still high, mostly in rural areas. If an area has a weak economy, more job opportunities will not push up inflation, but rather create opportunities for workers and may boost productivity. Economic growth trends can change at any time, and to make more accurate predictions, it is not just the responsibility of the Federal Reserve, but also requires comprehensive consideration of decisions made by governments, businesses, and labor forces at all levels.

Currently, the Federal Reserve is grappling with the question of whether the economy has been too good. The key lies in how the real growth rate is, and this is something that no one can predict accurately. Many of the speeches by Fed officials now mention "caution." Inflation is still relatively high, so it is not yet time to celebrate victory or pour cold water on recent good economic data.