Gordon, an expert on productivity at Northwestern University, says the economy's potential growth rate for the next two decades will be no better than an annual rate of 2.35%, down from the 2.86% figure for the previous 20 years. As of January, the Fed's official view was that the economy can sustain growth of 2.5% to 2.7%. An updated forecast is due within weeks.
In the short run, as the financial system heals from the self-inflicted wounds of recent years, the economy is likely to perform even more poorly. More than 5 million jobs have disappeared in the past 15 months, and consumers and corporations are focused on paying off debt rather than spending or investing in new productive capacity. Federal Reserve Chairman Ben Bernanke told Congress earlier this week that the economy should bottom out in the next few months before beginning its long climb back to normalcy.
"Even after a recovery gets underway, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while," Bernanke said.
Historically, economies recover more slowly following financial crises than after garden-variety recessions, according to the International Monetary Fund. Today's global downturn, triggered by a financial disruption and synchronized across all major economies, represents the worst possible confluence of circumstances.
"We have to re-evaluate potential growth, given the fact that some of the housing (related) growth was not real and the output of the financial system was not real," says Harvard University's Kenneth Rogoff, former chief economist at the IMF.
The U.S. economy's shrunken horizons are a far cry from the halcyon days of 2000, when new Internet and wireless technologies appeared to promise dramatically improved growth. Then, surging productivity far beyond what Europe and Japan were experiencing contributed to a sense of limitless economic possibilities. Fed officials in early 2000 anticipated potential output growing at an annual rate of 4%, up sharply from just 2.3% in the early 1990s.
Different, but more stable
Now, as the U.S. digs out after twin housing and credit bubbles, significant economic energy is being drained by the crisis and its consequences. The de-leveraging — or debt repayment — process that is underway will be long-lived. As late as 2011 and beyond, corporations still will be confronted with the need to pay off or refinance massive amounts of debt issued during the leverage boom of 2005-07, according to UBS.
The disruption in financial markets that began in 2007 and intensified last fall after the Lehman Bros. bankruptcy canceled or delayed business investments that would have paid off in greater productivity. In January, refiner Valero said it would cut capital spending by $800 million this year. It's in good company: 69% of those responding to a PricewaterhouseCoopers global CEO survey said they planned to trim investment amid the crisis.
The nation's wounded banks also are in no condition to efficiently allocate capital. Operating in some markets with government guarantees against loss while worrying about how their capital bases will hold up amid a continuing downturn, the banks may husband their resources rather than risking them on business ventures. "We're going to go back to a more basic kind of banking — less risk-taking, less leverage," said Desmond Lachman, a former IMF economist now at the American Enterprise Institute.