COMMENTARY: How fast can our economy grow at full employment?

When the economy is not at full employment, there are more people searching for work than there are jobs available. When a job opens up, there are people to fill it. There are empty business rentals searching for occupants. When a tenant shows up, a new business will open. There are factories operating at less than full capacity. When an order arrives, production expands.

An economy can grow faster if it has unemployed people, buildings and equipment. All that's needed is someone wanting to buy what businesses and their employees can produce.

What happens when the economy reaches full employment? There may be no one to fill new jobs when they open. The number of people newly entering the labor force, minus the people retiring, puts a limit on job growth. An entrepreneur may have a great business idea, but no empty space to rent. Space becomes available only when construction companies and their workers build new buildings. A factory operating flat out may have to refuse an order until new equipment is purchased and new employees are hired.

At full employment, an economy is limited by the growth of the labor force, and the growth of the tools and technology that workers use. The United States economy is pretty close to full employment as of mid-2017. The unemployment rate is 4.3 percent, the lowest rate since January 2001.

The labor force is growing slowly, only 0.8 percent over the past year. Between 1980 and 2007 — when the baby boomers were old enough to work but not to retire — the labor force grew 1.4 percent per year. Now the number of people newly available to work is growing more slowly.

Labor productivity is growing slowly too. It can be measured by the value of goods and services that the average worker produces. Productivity had a burst of growth between 1996 and 2005, with all that new information technology. Output per worker grew 2.1 percent per year. But productivity growth has slowed. Since 2005, it's grown only 0.8 percent per year.

Add it up. During the years 1996 to 2005, a fully-employed economy could grow 3.5 percent per year, the sum of 1.4 percent labor force growth and 2.1 percent productivity growth. Now, though, with 0.8 percent labor force growth plus 0.8 percent productivity growth, the economy can average only 1.6 percent per year.
 
What if consumers, or businesses, or governments, or the rest of the world try to buy goods and services at a pace above 1.6 percent per year? Then something's got to give. Businesses might raise wages, to attract people from retirement or out of the home. Then labor force growth would increase. Businesses that can't find workers might invest in automation. Then productivity would increase. Businesses might offer training to less-qualified people. Then the unemployment rate would fall a little. Businesses might raise prices in the face of spending they can't satisfy. Then inflation would increase.

All these things could happen in 2018. Consumers especially seem ready to spend, with more jobs available, stock and home prices rising and gas prices low. Real gross domestic product will probably grow faster than 1.6 percent—maybe 2.2 percent in 2018. Both the labor force and productivity will grow a little faster. The unemployment rate may fall a little, perhaps to 4.1 percent by August 2018. The inflation rate may rise a bit, from 1.7 percent now to 2.2 percent over the next year.

And, with unemployment down and inflation up, the Federal Reserve would have reason to raise the federal funds rate four times, by a quarter-point each time, from 1.2 percent now to 2.2 percent next August. The ten-year Treasury bond rate would rise maybe half-a-point, to 2.8 percent.

Here's news: this forecast will be wrong. Will it be just a little wrong, so that the story it tells is mostly right? Or a lot wrong, because of shocks to spending or productivity? Shocks from China, Europe, energy prices, tax and spending policy, even a failure to raise the debt limit could change this forecast up or down. But that would be shocking.