MORGAN STANLEY: The Economy's Potential Growth Rate Has Now Permanently Declined

Sorry. We're not going back to the old normal. At least that's according to Morgan Stanley.

In a new note, economist Vincent Reinhart estimates that the economy's potential growth rate is now around 2% (down from 2.5%) and that 6% is probably what represents "full employment" and that the Fed will have to acknowledge that there's less "slack" in the system than they thought? This chart captures the new trend.

This chart shows the new impaired trend.

Morgan Stanley

So what's behind the new slow potential growth rate for the US economy?

Reinhart identifies two big trends. One is declining Labor Force Participation Rate, a trend which started well before the recent slump. And the other is declining productivity. Fewer labors and less productivity make it hard to keep up the same growth pace.

These two charts tell the story of declining Labor Force Participation and declining productivity.

Morgan StanleyLabor Force Participation

Morgan StanleyOutput Per Hour

Again, the big ramifications here are probably for the Fed, for if this is true, may get unwanted levels of inflation faster than they want or expect.

Bigger picture is that this is something that a lot of folks are talking about right now: The end of extensive slack in the economy. For example, this is a chart from a new chartbook from Deutsche Bank's Torsten Slok, who spends a lot of time look at wage inflation trends.

Deutsche Bank

This is the hot story everyone is talking about.