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Projecting GDP Growth Using Labor Force Participation Trends

Thursday, November 27, 2014

Future real gross domestic product (GDP) growth could occur at an average annual rate 1 percentage point lower than before the Great Recession, according to a recent Economic Synopses essay, published by the Federal Reserve Bank of St. Louis.

Before the recession, real GDP per capita grew at a 2.2 percent annual average. It has grown at a 1.4 percent annual average since 2010 and is now about 15 percent below its 1955-2007 trend. St. Louis Fed Senior Economist Fernando Martin noted that the decline in output is associated with a similar decline in employment: “Arguably, the decline in employment is driven by a steady decline in labor force participation largely caused by demographic changes in the U.S. population (e.g., the aging of the “baby boom” generation).”

As a way to correct for the effects of changing demographics on output, Martin also looked at real GDP per labor force participant. He showed that real GDP per labor force participant, which fell sharply during the past recession, has been converging back to trend since the recession’s end. As of the third quarter of 2014, it was only 2 percent below its prerecession trend. “Thus, when viewed through this lens, the supply of output per labor force participant in the U.S. economy appears to be almost back to normal.”

Projecting GDP

Martin then used current labor force and population projections to project future output, assuming real GDP per labor force participant will grow at its current pace until closing that 2 percent gap with its prerecession trend, then continue to grow at its historical 1.5 percent annual average.1 Under these assumptions, output per capita would be about 20 percent below its trend and grow at a modest 1.3 percent annual average by the fourth quarter of 2022.

These calculations imply that real GDP would grow at a 2.3 percent annual average until 2022, declining slightly toward a 2.0 percent annual average by the next decade. These rates are significantly lower than the 3.3 percent average annual growth rate of real GDP between 1955 and 2007.

Martin concluded, “When expressed as a fraction of the labor force, the output gap is essentially closed and there is no further role for stabilization policies. Assuming current demographic trends persist, we should not expect output and output per capita to return to their prerecession trends.”

Notes and References

1 For the labor force, Martin used the most recent Bureau of Labor Statistics projections for the next decade. Population projections were from the U.S. Census Bureau.

Additional Resources

Posted In LaborOutput  |  Tagged fernando martingdplabor force participation
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