Follow Joshua McCallum

Ever since the financial crisis, there are many who have claimed that economies like the US are now on a trajectory of permanently slower growth. However, the burden of proof should be on demonstrating why trend growth has suddenly changed its behaviour. Looking at growth over the very long run (back to 1870) is illuminating.

A fourteenth century English monk reading most of today’s financial commentary would likely end up cutting it out and dumping it in the bin. Well, he would if his name were William of Occam. Occam bequeathed to the world one of the most useful, and unfortunately least used, analytical maxims, which can be paraphrased as "of two equally plausible explanations, the simplest is always to be preferred". This is known as Occam's razor for its demands to cut away unnecessary arguments. Faced with two different explanations that fit the facts, but neither of which can be demonstrated to be wrong, you should throw out the long, convoluted explanation and focus on the simple one. Or to put it another way, the burden of proof is on the complicated explanation to make its case.

One particular debate that would have Occam sharpening his razor would be the argument about trend growth. Ever since people first started using the term “new normal”, there have been many who have claimed that the financial crisis has changed everything and economies like the US are now on a trajectory of permanently slower growth. Interestingly enough, if you substitute the words “financial crisis” with “productivity miracle” and substitute “slower” with “higher” you get what other people were saying about trend growth before the financial crisis. In hindsight, everyone is now very scathing of those who claimed that “this time is different” during the boom. This should make us wonder about those who are saying “this time is different” during the gloom.

Experience has surely taught us to place the burden of proof on those who claim that “this time is different”, for better or worse. Occam would agree: the simplest explanation has to be that trend growth has not suddenly changed its behaviour. The claims that it is different are plausible, but since we cannot prove or disprove either theory today, the simpler explanation that there has been no sudden change is to be preferred. The pessimists' first line of argument is the massive deviation from the pre-crisis trend (chart 1). This is such a break from the past, they argue, that it must be a new trend. 

Chart 1: The short view

Real GDP since 1980, USD trillions in 2009 prices with pre-crisis (1980-2008) trend extrapolated until today 

Source: BEA, Angus Maddison, UBS Global Asset Management  

Then again, there is the past and then there is the past. Estimating the trend from 1980 onwards assumes that the years before 1980 are not relevant. The data allows us to go back a lot further. The official data goes back to 1929, and academic work by the late Angus Maddison provides estimates all the way back to 1870. Growth is exponential, so it is hard to show it clearly in a chart like chart 1. Instead we can show GDP on a logarithmic scale because, using this scale, the slope of the line equals the growth rate. Plotting GDP back to 1870, the most striking factor is just how straight the slope is (see chart 2); in other words, just how constant the trend growth rate is. For the last 150 years the US economy has grown by an average of 3.25% a year.

There is one very notable decade-long divergence from that trend caused by the Great Depression from 1929, and it is quickly clear why it was labelled ‘great’. In comparison, the recent deviation is barely visible. Afterwards, GDP in the US eventually went back to its long-run trend. If the Great Depression was not enough to knock trend growth off track, it is hard to see how our recent so-called “Great Recession” should be able to change things forever.

Chart 2: The long view

US real GDP since 1870 (USD trillions in 2009 prices), log scale

Source: BEA, Angus Maddison, UBS Global Asset Management  

The long run is interesting, but as Keynes famously said, “in the long run, we are all dead”. He was not being unduly pessimistic (he was referring to the people alive at that point in time), but the point holds: how relevant was the very long run for people living through the 1930s? And how worried were people living in the 1960s that growth at that time was above the long-run trend?

Finding these prolonged deviations from the very long run 140 year trend is trickier, but we can use statistical techniques to try to identify cycles in growth rates that last at least 30 years (as opposed to the standard business cycle which is closer to 10 years). As our memory of economic history would suggest, this reveals that trend growth can diverge quite substantially for long periods of time (chart 3). Growth has been gradually slowing since the mid-1980s on this estimation method, but the difference is small compared to the Great Depression (and be warned, other statistical methods can give different results). So not only does it look like trend growth was slowing before the financial crisis, it also slowed to ‘only’ 2.6% – a little bit above what the Fed sees as the longer-run growth rate of the economy.

Chart 3: Trendy

Trend GDP growth estimates using a long-run average and an estimate using 30+ year cycles, % YoY

Source: BEA, Angus Maddison, UBS Global Asset Management

Note: Growth is identified using a band-pass filter

The pessimists would have us extrapolate this recent slowing into the future to a world of almost permanently lower growth. They cite various reasons, including the demographics of an aging population, a lack of business investment, and a huge overhang of debt. All of these are indeed plausible arguments and could turn out to be right (but hopefully not). Yet different but equally plausible arguments could have been made at many times in the past about why growth would be permanently slower, not least during the 1930s. In the end, periods of slower growth have always reversed and moved back to (and above) the long-run trend.

Despite all the complicated and detailed arguments that economists may muster about why trend growth might now be lower, the simpler observation to be overcome is that growth has always snapped back to a stable, long-run trend. It is less Occam’s razor than Occam’s ruler, because the best predictor so far of trend growth is simply drawing a straight line through the (log) data.


The views expressed are as of November 2013 and are a general guide to the views of UBS Global Asset Management. This document does not replace portfolio and fund-specific materials. Commentary is at a macro or strategy level and is not with reference to any registered or other mutual fund. This document is intended for limited distribution to the clients and associates of UBS Global Asset Management. Use or distribution by any other person is prohibited. Copying any part of this publication without the written permission of UBS Global Asset Management is prohibited. Care has been taken to ensure the accuracy of its content but no responsibility is accepted for any errors or omissions herein. Please note that past performance is not a guide to the future. Potential for profit is accompanied by the possibility of loss. The value of investments and the income from them may go down as well as up and investors may not get back the original amount invested. This document is a marketing communication. Any market or investment views expressed are not intended to be investment research. The document has not been prepared in line with the requirements of any jurisdiction designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The information contained in this document does not constitute a distribution, nor should it be considered a recommendation to purchase or sell any particular security or fund. The information and opinions contained in this document have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. All such information and opinions are subject to change without notice. A number of the comments in this document are based on current expectations and are considered “forward-looking statements”. Actual future results, however, may prove to be different from expectations. The opinions expressed are a reflection of UBS Global Asset Management’s best judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as a result of new information, future events, or otherwise is disclaimed. Furthermore, these views are not intended to predict or guarantee the future performance of any individual security, asset class, markets generally, nor are they intended to predict the future performance of any UBS Global Asset Management account, portfolio or fund.

© UBS 2013. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.