Markets and Economy

6 Flawed Assumptions About the Economy

Throughout the recovery, popular assumptions about the economy have been later proven inaccurate. Here are six instances in recent years when the first impression led to a flawed understanding of the economy.
Jim Glassman, Head Economist, Commercial Banking
November 8, 2017

First impressions can be useful in daily life—but in economics, the initial take in a headline often leaves out important underlying trends. Throughout the recovery, popular beliefs about the economy have been later proven inaccurate. Here are six flawed assumptions about the economy from recent years that illustrate the importance of looking past first impressions:

Assumption No. 1: Slow Growth Points to Economic Weakness

GDP figures can be misleading. Throughout the recovery, some people have claimed that slow growth is a sign of lingering economic weakness. However, headline growth figures are only as important as their relation to the economy’s underlying potential for expansion.

Growth may have slowed by a full percentage point from past decades, but this doesn’t mean the economy is falling short of its potential—instead, our aging population has slowed the rate of growth. As long as the economy is on a trajectory to reach full capacity, there is nothing fragile about this recovery.

Similarly, the falling labor force participation rate can give the impression that the job market remains soft. But compared to the last business cycle, there are 20 million more Americans over the age of 50 today. The lower rate of labor force participation today is simply a symptom of the ongoing wave of baby boom retirements rather than a sign of labor market weakness.

Assumption No. 2: The Official Unemployment Rate Tells the Whole Story

Back in April 2014, the headline unemployment rate slid below 6.5 percent, sparking calls for the Federal Reserve to begin raising interest rates. But a closer look showed that this first impression vastly underestimated the amount of slack remaining in the labor market.

The official unemployment rate did not include millions of discouraged workforce dropouts who had stopped looking for jobs. As the job market improved, this population returned to the workforce. Since then, the economy has been able to continue creating jobs at a steady pace for three full years without causing undue tightness in the labor market.

Monthly job figures can also be misleading. Some analysts were disappointed by this October’s 261,000 new jobs, which seemed like an anemic rebound after September’s hurricane-driven losses. But a deeper look shows that figures for previous months have been revised upward by some 90,000 jobs. The rate of job creation actually held steady throughout autumn, despite several natural disasters.

Assumption No. 3: China’s Mounting Debt Will Lead to a Hard Landing

At first glance, China’s corporate sector appears overburdened with debt. So when China missed its 7 percent growth target in early 2016, markets around the world shuddered, anticipating a hard landing for the nation’s debt-fueled boom.

But the hard landing failed to materialize. These worries might have been appropriate if applied to the US or Europe, but China is in a fundamentally different situation. Its economy is still urbanizing, with the potential to grow at double or triple the rate of Western economies for decades to come. Any imbalances created by the nation’s debt-fueled expansion should be readily absorbed by its consumers’ ever-growing demand.

Assumption No. 4: Income Inequality Is an Inevitable Result of Capitalism

A superficial look at America’s growing wealth gap might lead some people to believe that inequality is the natural result of the free market. But recent research suggests that workplace efficiency and automation led by innovative “superstar” firms are actually responsible for labor’s shrinking share of the economy.

Assumption No. 5: The Model for Inflation Isn’t Working

A quick look at inflation in 2017 would seem to discredit the traditional framework that links rising prices with the top of the business cycle. But monthly inflation figures are volatile, and supply shocks—such as falling telecom prices or a commodities glut—can skew prices on a broad range of goods.

Without a viable alternative model, a moderate inflation undershoot should not discredit a policy framework that has successfully supported the recovery for nine years.

Assumption No. 6: Layoffs Are Always a Sign of Trouble

Layoffs are the most reliable, comprehensive and timely economic indicator—and, in normal times, they can provide an accurate gauge of economic distress. So when unemployment filings jumped by 175,000 following September’s hurricanes, it appeared that a large portion of the workforce in storm-damaged areas no longer had a workplace to which they could return.

Fortunately, many who filed for unemployment insurance were not unemployed for long. The number of people actually drawing unemployment benefits fell throughout September, a sign that many post-hurricane layoffs were short-lived. Initial jobless claims made the storms’ economic damage appear devastating, but subsequent weeks have shown the affected regions getting back on their feet.

Overall, economic indicators can be volatile—but the broader US economy rarely turns on a dime. It’s important to look past the headlines and examine how data points fit into long-term trends. In economics, first impressions can be misleading.

View our economic commentary disclaimer.

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