The U.S. economy is on a hot streak it hasn't seen in 20 years

By Jeffry Bartash

Fed rate hikes haven't slowed the economy down

The U.S. economy is guilty of speeding.

After another burst of growth in early 2024, the economy is on track to expand by at least 2% for the seventh quarter in a row. Just how strong is that? The last time the U.S. pulled off such a feat was 20 years ago, in 2003-2004.

What's remarkable about the current expansion is that it's happening after the Federal Reserve rapidly raised interest rates to the highest level in more than two decades. High borrowing costs usually slam the brakes on the economy.

Not this time.

If anything, the economy has actually grown faster since last summer, when the Fed ended a series of hikes that brought its benchmark short-term interest rate to a 23-year peak of 5.5%.

Gross domestic product, the official scorecard of the economy, ramped up to 4.9% in the 2023 third quarter That marked the fastest increase since 2014, if the stimulus-fueled recovery from the pandemic is set aside.

GDP also rose 3.4% in the fourth quarter and the latest estimates suggest the economy could grow close to 3% in the first three months of 2024. First-quarter GDP will be released in two weeks.

It wasn't supposed to happen.

The recession that wasn't

In March of 2023, for instance, top Fed officials predicted the economy would expand a meek 0.4% for the full year. And GDP in 2024 was only seen rising to a mediocre 1.2% in the eyes of Fed leaders.

At the same time, most Wall Street economists forecast an impending recession.

Instead, the U.S. has grown an average of almost 3% a quarter since the middle of 2022 - far above what is considered its "potential" growth rate.

Just what is that? Potential growth refers to the fastest speed at which an economy can expand in the long run if conditions are ideal.

Until recently, the potential U.S. growth rate was viewed as less than 2%. Put another way, the economy could not consistently grow any faster than that without stoking inflation or causing other major mischief.

Economists are revisiting those assumptions.

Immigration and GDP

The biggest wild card is immigration. One of the two biggest determinants of economic growth in the long run is a rising population. A bigger population means more people working, spending and consuming.

A non-partisan congressional research agency estimates net immigration to the U.S. - much of it illegal - rose by 2.6 million in 2022 and 3.3 million in 2023.

By contrast, net immigration rose an average of 900,000 a year from 2010 to 2019.

A recent spike in productivity is another possible though more controversial reason.

Productivity is the key to a higher standard of living. It rises when workers can produce more goods and services in the same amount of time as they did the year before.

Some economists contend the use of more technology and even the early adoption of artificial intelligence may be lifting productivity.

Productivity has grown an average of 2.6% in the past five quarters, significantly faster than in the 20 years preceding the pandemic.

Others scoff at the idea, pointing out that productivity is hard to measure and doesn't change quickly. The pandemic also threw productivity estimates out of whack, resulting in unusually large declines in 2021 and early 2022. The recent rebound might just be a statistical catchup.

The adoption of AI, what's more, is likely to take time and it will be a while before the technology reshapes the U.S. economy. Major technological advances generally take years to work their way into business practices.

"In my view, it is grossly premature to draw such sweeping conclusions," said chief economist Stephen Stanley of Santander Capital Markets. "In fact, such a development could take years to emerge."

Consumers keep spending

What else can explain surprisingly strong economic growth? Economists offer a handful of explanations.

A strong labor market, for one thing. Steady hiring, low layoffs and a rock-bottom unemployment rate have made workers feel secure in their jobs.

When Americans feel secure, they tend to spend more money. And that's exactly what has been happening.

Consumer spending, the main engine of the economy, has risen by an average of 2.8% a quarter in the past year after accounting for inflation. That's a half-percentage point faster than from 2010 to 2019.

What's partly allowed households to spend more is the fastest increase in wages since the 1980s. A shortage of workers has given employees more leverage to demand higher pay.

Workers need more money, of course, to keep up with rising prices due to high inflation. Pay is just barely keeping ahead of inflation for most people.

Whatever the case, Americans are spending more than ever on travel, recreation, dining out and other services.

"The bottom line here is the U.S. consumer continues to drive the economy," said economist Ali Jaffery of CIBC Economics.

Last but not least, higher government spending has helped to fuel growth. Local, state and federal outlays have risen an average of 4.5% in the past six quarters, almost double the annual average from 2010 to 2019.

The Biden administration has approved hundreds of billions in subsidies for green-energy initiatives and efforts to promote more domestic manufacturing of high-tech products like semiconductors deemed critical to national security.

The surge in spending, especially at the federal level, has pushed U.S. budget deficits to $1 trillion-plus annually and sharply increased interest payments on the national debt.

The bill might come due eventually, economists say, but in the short run, the flush of government spending has given a big shot of adrenalin to the economy.

-Jeffry Bartash

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04-17-24 0858ET

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