No ordinary recovery

Slowly does it

United States

By many measures, the American economy looks healthy. Unemployment is back to pre-crisis lows of close to 5%. Growth is running at a decent clip, at least by recent standards. Many Americans are better off than a year ago, thanks to cheap fuel and energy. Yet the laborious recovery from the financial meltdown is still incomplete. Inflation and interest rates remain at historic lows; wage growth, in cash terms, is paltry. In 2016 this will begin to change, but only slowly.

Interest rates will rise first. Janet Yellen, the Federal Reserve’s chairman, has long emphasised the need to raise rates before inflation emerges. History points to a quick climb. The last time the Fed began an interest-raising cycle was in June 2004. A year later, rates stood two percentage points higher.

But things look different now. The link between a booming labour market and fattening pay packets has weakened. Despite firms adding about 3m staff to their payrolls in the past year, wage growth plods along at a meagre 2%. Until there are concrete signs of stronger wage growth, the Fed will be cautious.

Rapid growth in wages is unlikely, for three reasons. First, falling union membership and global competition have left workers in a weaker bargaining position than ever before. Labour’s share of national income is hovering around 63%; at the turn of the millennium it exceeded 70%. Even in a tight labour market, workers will find it hard to negotiate big pay rises. Second, labour-market participation remains low, meaning some workers can probably be tempted back into the workforce before wage growth takes off.

Third, growth in the productivity of labour—a crucial determinant of average pay—has been weak. From 2010 to 2015, it averaged just 0.5% a year, compared with 2% annually in the five years before that. This will improve a bit in 2016 as firms, faced with hiring difficulties, seek to get more from their existing workers. But productivity-boosting investments take years to pay off.

Most uncertain is the outlook for inflation. Weak wage growth should keep prices down. But many Fed rate-setters expect inflation to rise quickly as lower oil prices and a strong dollar drop out of the numbers.

They could be wrong. With the Chinese economy slowing, and Europe’s recovery lagging behind America’s, the dollar could rally further. And low inflation has proved stubbornly persistent across the globe.

The year ahead will shed light on the economy’s long-run prospects. Further weak productivity growth will see pessimists evoking a “new normal” in which living standards rise only slowly. And if interest rates and inflation stay low, “secular stagnation”—a chronic shortfall in demand and investment—will be blamed.

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