Markets and Economy
The Economic Expansion Enters Year 11
The current expansion has now reached record territory, becoming the longest-running period of consecutive economic growth in US history. Now that the economy has reached this milestone, where does it go from here?
In June, the current business cycle will officially enter its 11th year of growth and become the longest-running expansion in US history. Economists at the National Bureau of Economic Research have reconstructed every business cycle since the nation’s founding; never before has the economy sustained more than 10 years of consecutive growth.
Given the unprecedented duration of the expansion, it may seem like a new downturn is overdue. But the business cycle doesn’t run on a clock—recessions require a trigger, and no financial imbalance has yet emerged to threaten the recovery. An environment of tame inflation and relatively few financial stressors may enable the record-setting expansion to run on for the foreseeable future.
A Dubious Distinction
The recovery’s longevity is partially the consequence of a severe recession. The 2008 downturn created a tremendous amount of slack in the economy, enabling a long period of above-trend growth before full employment returned. The depth of the prior recession meant the recovery could run for several years before overheating.
Policymakers deserve credit for recognizing the true amount of slack in the labor market. Throughout the recovery, the Federal Reserve resisted premature calls for monetary tightening; a long period of near-zero interest rates and two rounds of quantitative easing successfully created the conditions for a full decade of sustainable growth.
Now that the economy has recovered its recessionary losses, however, it’s difficult to tell how much longer the recovery will last. History shows that periods of full employment are often short-lived. During the peaks of past business cycles, inflationary pressure and financial imbalances emerged, which triggered new recessions. But the current expansion shows no evidence that the next recession is on the horizon.
Searching for Triggers
Although a return to full employment has often preceded past recessions, a tight labor market isn’t inherently destabilizing. Rather, full employment has historically accompanied overheating in the broader economy; when the nation’s aggregate demand outstrips its potential supply of goods and services, the resulting inflationary pressure has tipped the economy into a new recession.
Over the past two decades, however, inflation has become untethered from the business cycle. Instead of falling during downturns and rising as the economy gains momentum, inflationary pressure during the current business cycle has held near the Fed’s 2 percent target—even through a historically severe downturn and the current prolonged recovery that followed.
Several competing theories attempt to explain inflation’s tame behavior. Globalization and deregulation are likely playing a role, and investors’ expectations are anchored by the Fed’s official 2 percent inflation target. But regardless of the forces moderating price pressures, the implications for the expansion are benign.
Tame inflation at a time of full employment implies that the economy’s true capacity is higher than commonly assumed. Productivity-boosting technologies and an increasingly skilled workforce may have raised the nation’s potential output, opening the door for noninflationary growth through the top of the business cycle. Rising worker productivity could keep the expansion going after the unemployment rate reaches its natural equilibrium.
This development would be excellent news for the business cycle. Stronger potential growth should support robust pricing for financial assets, prolonging the bull equity market that’s pushing household wealth to new heights. And tame inflation will likely keep interest rates near their natural long-term equilibrium, encouraging capital investment that could increase future production.
Maintaining Financial Balance
The past two recessions have been triggered by financial imbalances: the popping of the dotcom bubble led to the 2001 downturn, and the collapse of residential real estate prices in 2008 caused a global financial crisis. Fortunately, no comparable asset bubbles appear to be inflating as the current business cycle nears its peak.
The Fed’s most recent quarterly Financial Stability Report highlighted only one area of concern: rising corporate leverage, driven by relatively large loans issued to businesses with high levels of debt.
This is an area to watch, but leverage isn’t necessarily destabilizing. For an asset bubble to emerge, investors must underestimate its risks. For example, in the late 1990s, equity investors were correct in their optimism about e-commerce, but many didn’t anticipate the high failure rate for dotcom startups.
The investors funding the current leverage boom, however, should be aware of the default risks. The current combination of strong demand and low interest rates has helped corporate credit perform well, with default rates and debt burdens near historic lows. As long as the risks are known, it’s not worrisome that investors are funding companies that take on leverage to pursue rapidly emerging opportunities.
The current business cycle won’t last forever; eventually, a disruption will cause the economy to contract. But there’s no reason to believe that will happen soon. Tame inflation and well-balanced financial risks are creating the conditions for a historically unprecedented period of prolonged, sustainable growth. The expansion may be old, but it appears to have plenty of life ahead.
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Jim Glassman, Head Economist, Commercial Banking
Jim Glassman, Head Economist, Commercial Banking
Jim Glassman is the Managing Director and Head Economist for Commercial Banking. From regulations and technology to globalization and consumer habits, Jim's insights are used by companies and industries to help them better understand the changing economy and its impact on their businesses.