Will retiring boomers derail U.S. growth?
By Carlos Torres and Rich Miller Bloomberg News
FRIDAY, APRIL 14, 2006
WASHINGTON A new Federal Reserve study suggests that the U.S. economy will probably slow more than expected over the next decade, as the retirement of the baby boom generation forces far-reaching adjustments in the way the economy works.
The study, to be published in July, projects a slower pace of work force growth than most economists now forecast, suggesting the economy cannot keep growing at the present-day pace without generating pressure for higher wages and inflation. The only way for the Fed to prevent that would be to use its traditional tool of pushing up interest rates.
The report "is such a revolutionary shot," said Ian Morris, chief U.S. economist at HSBC Securities USA in New York. It may lead some economists to recast their forecasts for everything from growth and employment to corporate profits and interest rates.
The study suggests that growth over the next 10 years will average less than 3 percent, instead of the 3.3 percent of the past decade, economists said. A 0.3 percentage point difference in growth in the $12 trillion U.S. economy translates into $360 billion over 10 years, equal to the size of Switzerland's economy. Nonfarm job gains, which averaged 200,000 a month in the 1990s, may be half that.
"This is a very big story," said Laurence Meyer, vice chairman of Macroeconomic Advisers and a former Fed governor. "It makes the challenge for the Fed a little greater."
While economists have known for years that the coming retirement of the baby boomers would be a drain on the labor force, the Fed study suggests that the United States is already feeling the effects and the impact in the next decade may be much bigger than previously thought.
The study projects what the authors call a conservative three percentage- point decline over the next 10 years in the labor-force participation rate - the percentage of people who are either working or looking for work. Much of that drop is driven by the retirement of the baby boomers, the 78 million Americans born from 1946 to 1964.
The participation rate is at the core of a simplified equation economists use to estimate the country's "potential" gross domestic product, or the rate of economic growth that does not cause inflation to accelerate. In that formulation, the percentage increase in the labor force and hours worked plus gains in productivity equal potential GDP.
The projected drop in the participation rate would "reduce the sustainable rate of economic growth relative to the robust pace experienced over the past decade or so," said the Fed report, which was written by staff economists. The paper carries a disclaimer that the opinions are those of the authors and not necessarily of the Fed.
The study suggests the labor force and hours worked will be growing by just 0.5 percentage point within five years, said Morris of HSBC. Adding in a two percentage point gain in productivity, which is close to the Congressional Budget Office's 2.1 percent forecast, leaves potential growth down at 2.5 percent by 2010, Morris said. If the number of hours worked also slows, the growth rate would be closer to 2 percent, he said.
Such an estimate is well below current government and private forecasts. The median estimate of economists surveyed last month by Blue Chip Economic Indicators calls for growth to average 3.1 percent from 2008 to 2012 and 3 percent from 2013 to 2017. The Congressional Budget Office projects growth of 3 percent on average from 2008 to 2012.
"We will have to rethink our measures of successful growth," said Douglas Holtz-Eakin, former director of the budget office and now an economist with the Council on Foreign Relations.
Not everyone is won over by the conclusions of the study, to be published in July as part of the Brookings Institution's Papers on Economic Activity. A preliminary version of the report is available on Brookings' Web site.
"We have a lot of experience in that area," said Stephen Goss, chief actuary at the Social Security Administration in Baltimore, whose participation rate forecasts are central to estimating revenue and expenditure streams for the U.S. retirement fund. "We don't see the rate declining as much as they do."
Social Security forecasts the participation rate will drop by about 1.1 percentage points in the next 10 years, said Goss, a third the decline projected by the Fed economists. If the Fed forecast is accurate, it would mean an additional 10 percent increase in the Social Security fund's $3.5 trillion projected deficit over the next 75 years, Goss said.
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