The U.S. economy’s steady growth – the longest stretch since World War II without a recession – is something of a mystery. Last summer, the yield curve inverted, which traditionally is the most reliable signal of an impending downturn. There were all sorts of plausible reasons the economy could take a turn for the worse – a mountain of increasingly risky corporate debt, a slowdown in China, President Donald Trump’s trade war, manufacturing weakness, increasing uncertainty about government policy and so on.
Why is the economy doing well despite all the headwinds? Trump supporters will tend to credit the president’s late 2017 tax reform. But this is unlikely. If the [$1.5 trillion tax cut] had made the economy more efficient, it would have led to a surge of business investment. But economics research finds little impact, and real private investment actually decreased in the second through fourth quarters of 2019.
It’s also possible, of course, that the tax cut has raised consumption by driving up aggregate demand. It’s also true that under Trump, deficits have risen to levels not seen since 2012.
The economy [may be] in a phase of boring normality.
But this is unlikely to have provided the economy with a major boost. First, the tax reform’s benefits flowed mostly to the wealthy. Wealthier people tend not to change their consumption much in response to changes in income because unlike poor and middle-class people, they have no pressing need to pay off their debts or buy necessities. Fiscal stimulus also tends to have much less of an effect when the economy is healthy than when it’s in recession. Thus, the tax cuts probably provided little stimulus while raising the deficit.
So if it wasn’t the tax reform, what’s keeping the recovery rolling along?
Low interest rates haven’t yet sparked a consumer borrowing boom; the ratio of household debt to gross domestic product remains at low levels and shows no signs of rising.
Trump might assert that his trade war helped. But exports didn’t go up during the past year. And if U.S. consumers are shifting from imported goods to domestically produced ones, the shift is very minor.
The recent weakness in business investment, especially in manufacturing, also suggests that the U.S. is not benefiting from a wave of reshoring by multinational companies. Chinese labor costs have risen, and China has become a less attractive investment destination because of the trade war and Chinese government policies. But so far, companies are mostly just shifting their overseas production to other low-cost countries such as Vietnam.
There’s no obvious driver of U.S. growth. The most likely explanation is the economy is simply in a phase of boring normality.
Most people tend to think of the business cycle as a series of alternating booms and busts. The U.S. economic record seems to confirm this. But while this is certainly possible, most macroeconomic models envision the economy as a production machine that just keeps chugging until some sort of shock disturbs it from equilibrium.
Since the end of World War II, there have been three main types of shocks that have thrown the U.S. economy off-kilter: financial bubbles and crashes, Federal Reserve interest rate hikes, or big increases in oil prices. None of these are threatening now. The rise in risky leveraged lending doesn’t seem big enough. Vivid memories of the crash of 2008 are probably preventing excessive speculation in stocks and housing, while the Dodd-Frank financial reforms and the scars of that disaster probably are holding back financial institutions from piling up excessive risks. Meanwhile, oil prices and gasoline prices are at moderate levels, and the Fed in 2019 reversed some of the interest rate increases of prior years.
Barring a new financial crisis, a major Chinese collapse, a sharp reversal of course from the Fed, or more dramatic meddling from Trump, the economy may simply keep sailing along.
Noah Smith is a Bloomberg Opinion columnist.
