With a growth rate of 2.4 percent last year, the American economy was operating at 0.6 percentage points above its physical limits to non-inflationary economic activity.
What are these physical limits? They are simply a combination of labor and capital resources and their ability to produce goods and services in an environment of stable costs and prices. Technically, that is also called the economy's (non-inflationary) growth potential.
And here is what that measure of the U.S. economy looks like. Taking last year's growth of the civilian labor force of 1 percent and a labor productivity growth of 0.8 percent gives the U.S. economy's growth potential of 1.8 percent.
That shows that the actual growth of the U.S. economy last year was quite good -- given that the economic system is still recovering from the disastrous financial crisis and its painful aftermath. Indeed, the lingering crisis hangover is the main reason why the economy's current ability to produce non-inflationary growth is more than a percentage point below the average growth potential of 2.9 percent observed during the period of 1990-2009.
A substantial decline in the growth of the labor force, productive capital stock and labor efficiency reflects the magnitude and the gravity of the problems that were created, and the fact that the U.S. Federal Reserve (Fed) still continues to struggle with errors of the past.
Catching the turning points
As always, the Fed's task of trying to achieve an acceptable combination of growth, employment and price stability is particularly difficult at times of major cyclical changes – exactly the situation they are facing at the moment.