How come? It`s simple: The stock and the efficiency of current labor and capital resources can only produce a noninflationary growth rate of 1. And that`s not new. That limited growth potential has been there last year, too, when the actual GDP growth was also 1.
Would the last Friday`s excitement about a 2.9 percent annual increase of average hourly earnings in September, and a decline of the unemployment rate to 4.2 percent, be a sign of increasing capacity pressures as the economy moved up to a faster pace of advance?
That`s quite possible because economic growth has accelerated considerably since it bottomed out at 1.2 percent in the spring of 2016.
Now, it is easy to imagine what would happen if large personal and corporate tax cuts were unloaded in an economy that is already growing well above its noninflationary potential.
Take, for example, that 2.9 percent annual wage increase in September. Even with an exceptionally high, 1.3 percent, productivity growth in the nonfarm business sector in the first half of this year, that would give a unit labor cost increase of 1. And that would be a significant shock to corporate profits, and equity prices, after an average 0.8 percent unit labor cost growth since the beginning of 2016.
That`s where the trouble would start: Businesses would then move to raise prices to protect their profit margins, setting in motion the proverbial wage-price spiral as the fiscal stimulus and low credit costs continued to support household consumption, and residential and fixed investments.
The Federal Reserve, of course, would be in on the act at some point in that process, first proceeding carefully and gradually to avoid crashing equity markets — until it became clear that gentle gradualism would have to give way to a strong and prolonged credit tightening.
We would then have the entry point into a recession of unpredictable amplitude and duration.
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