EISEN: Is the uncertainty what's holding back U.S. growth? How do we get out of this sub 2% or 2.5% level?

FISCHER: Well, technically we have to get something moving on productivity growth and that's not something we're good at doing. We don't know precisely how to do it. And we're all trying to find out whether what's going on is a long term change or a result of the cyclical situation. We'll get that right at some point. And when that changes, we'll go back to higher rates of growth. But it really turns on productivity. We've done everything we can and we've got achievements on employment. But productivity isn't going up and that's the remaining big factor in growth.

EISEN: if this is a long-term sort of secular story, stuck in low growth, as Yellen seemed to hint more so in her last news conference, what does the fed do about that?
FISCHER: Well, we can run as good a monetary policy as we like, but we will not have a direct influence on productivity growth. I mean, being more predictable, et cetera, will encourage more investment. But it isn't going to make an enormous change. People have to get more – we're looking for more investment to help get productivity going.

Some observers suggest conducting a comprehensive review of regulations at the national, state and local levels. They argue that, in some cases, excessive regulation and fees might be creating undue burdens on capital investment, lending, and the formation and growth of small business. This may help to explain why business investment and small-business formation have been disappointing over the past several years.

My position has been, and remains, cautiously optimistic. There is some evidence that the deep recession had a long-lasting effect in depressing investment, research and development spending, and the start-up of new firms, and that these factors have, in turn, lowered productivity growth. With time, I expect this effect to ease in a stronger economy.  I also see no obvious slowdown in the pace or the potential benefits of innovation in America, which likewise may bear fruit more readily in a stronger economy.

The most important factor determining continued advances in living standards is productivity growth, defined as the rate of increase in how much a worker can produce in an hour of work. Over time, sustained increases in productivity are necessary to support rising household incomes. … I mentioned earlier the sluggish pace of wage gains in recent years, and while I do think that this is evidence of some persisting labor market slack, it also may reflect, at least in part, fairly weak productivity growth. There are many unanswered questions about what has slowed productivity growth in recent years and about the prospects for productivity growth in the longer run. But we do know that productivity ultimately depends on many factors, including our workforce's knowledge and skills along with the quantity and quality of the capital equipment, technology, and infrastructure that they have to work with. As a general principle, the American people would be well served by the active pursuit of effective policies to support longer-run growth in productivity. Policies to strengthen education and training, to encourage entrepreneurship and innovation, and to promote capital investment, both public and private, could all potentially be of great benefit in improving future living standards in our nation.

So, we -- our productivity growth has been -- is a factor that affects the pace of improvement in the labor market. Productivity growth has been extremely slow for the last couple of years. And I think in part, the pace of improvement in the labor market that we're projecting reflects the notion that there's likely to be some pick up in the pace of productivity growth.

Obviously, that's something that's quite uncertain, and it's conceivable that if productivity growth disappoints -- something I hope that we won't see, because that has very negative implications for living standards -- we could conceivably see faster improvement in the labor market.

Yet the labor market’s journey is not yet complete – more progress needs to be made. My outlook is that as the expansion continues, firms will continue to add to their payrolls and the unemployment rate will continue to decline. I expect that by the end of next year, the unemployment rate will fall to around 5½ percent, which is what I view as the “natural rate,” or longer-run rate, of unemployment.

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Putting all of this together, I expect growth over the next six quarters to be somewhat above my estimate of trend growth, which I put at around 2.5 percent. Of course, there is always a good deal of uncertainty around estimates of trend growth, perhaps even more so today in the aftermath of such a deep recession. I am a bit more optimistic than some about longer-run growth because while productivity growth has been running low, I think it is good to remember the experience of the 1990s. Back then, over a period of several years, many forecasters revised down trend growth estimates only to subsequently revise them up significantly in response to strong productivity growth.

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One might ask whether that’s a reasonable inflation forecast given that we haven’t seen much acceleration in wages yet. I believe it is. Cleveland Fed analysis, based on several measures of wages and broader compensation, indicates that it is difficult to find a lead-lag relationship between wages and prices – the strongest correlations are contemporaneous ones, especially since the mid-1980s. We should expect wages to rise with prices, not necessarily lead prices. In my view, it would not be prudent for policymakers to simply wait for wages to accelerate before assessing the implications of the stance of monetary policy for future price inflation. Indeed, policymakers must always be forward looking.

At the end of the day, it remains difficult to disentangle the cyclical from the structural slowdowns in labor force, investment, and productivity. Adding to this uncertainty, as research done at the Fed and elsewhere highlights, the distinction between cyclical and structural is not always clear cut and there are real risks that cyclical slumps can become structural; it may also be possible to reverse or prevent declines from becoming permanent through expansive macroeconomic policies. But three things are for sure: first, the rate of growth of productivity is critical to the growth of output per capita; second, the rate of growth of productivity at the frontiers of knowledge is especially difficult to predict; and third, it is unwise to underestimate human ingenuity.

Since the end of the recession, real GDP has grown at an average annual rate of just 2.1 percent. In contrast, in the 60 years before the recession, real GDP grew at an average annual rate of 3.5 percent. Based in part on that long track record, many forecasters, myself included, were expecting growth to pick up to a more robust pace. More recently, however, I have come to the conclusion that a sustained acceleration of growth to something over 3 percent in the near future is unlikely. Given what we know, it strikes me as more likely that growth will continue to average somewhere between 2 and 2 1/2 percent. Let me briefly explain why.

It's helpful to start by thinking of the growth in real GDP as the sum of two components: growth in employment and growth in GDP per employee, a measure of productivity growth. When you calculate these two components, you find that both have slowed considerably since the Great Recession.

Taking these in turn, the rate of growth in employment has been about two-thirds of the rate we saw in the decades prior to the Great Recession. Part of that decline reflects structural developments such as slower growth in the working-age population, the aging of the baby boomers and the rise of enrollment in educational institutions. In addition, we've seen a gradual secular decline in the labor force participation rates for people in the prime working-age group aged 25 to 54. Some economists attribute this to workers becoming discouraged about their job market prospects and argue that the unemployment rate is understating the amount of "slack" in the labor market. Our research indicates, however, that there is always more slack than indicated by the standard unemployment rate, and by some measures there seems to be no more additional slack now than is typically associated with the current level of the unemployment rate.

Productivity growth, the other component of real GDP, grew fairly rapidly in the early postwar period, rising at a 2.7 percent annual rate from 1948 to 1969. Productivity growth then slowed, rising at a 1.4 percent annual rate from 1969 to 2007. And since the fourth quarter of 2007, productivity growth has averaged only 1.0 percent per year.

An active debate has sprung up concerning prospects for future productivity growth. Some economists have suggested that major, broad-based advances in technology are far less likely than in the past, and that we should prepare for a relatively stagnant productivity trend. I am not so gloomy, however, in large part because of the amazing historical record of technological innovations that solve current problems and simultaneously open up new possibilities for future innovations. Having said that, the difficulty of forecasting output per worker suggests that the middling productivity gains we've seen over the last few years are probably the best guide to near-term productivity trends. Thus, I am not expecting an imminent acceleration in productivity growth.

Productivity growth is critically important because it's what drives growth in real wages and real household income, which in turn ultimately drives consumer spending. Some proponents of the view that GDP growth will soon accelerate argue that a pickup in productivity growth will boost disposable income trends and thereby set off an acceleration in consumer spending. Data earlier in the year seemed to indicate that such an acceleration might be in train. More recent household spending figures suggest otherwise, however

The housing market has also perplexed forecasters over the course of this expansion Potential homebuyers now seem to be more conscious of the financial risks of homeownership than before, and housing demand has been shifting toward multifamily rental units. Moreover, the overhang of homes associated with foreclosures and seriously delinquent mortgages remains elevated, and this is dampening housing market activity. Thus, I am expecting residential investment to make only modest contributions to overall growth over the near term.

These three factors subdued productivity growth, moderate consumer spending growth and a more tempered expansion in housing construction are keys to my assessment that overall economic growth is likely to average between 2 and 2 percent over the near term, which is around the average rate we've seen for this expansion.

One recent trend that is particularly disturbing is stagnation in the formation of new firms. Statistics from the Bureau of Labor Statistics (BLS) show that the number of establishments in operation for less than one year rose between the mid-1990s, when the data start, and the early 2000s. But, smoothing through the ups and downs of the business cycle, new firm formation has been roughly flat since then. Moreover, the number of individuals working at such firms stands almost 2 million below its peak in 1999. Given the role of innovation by entrepreneurs and the well-documented importance of successful young firms in creating jobs, these trends are disheartening.
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One recent trend that is particularly disturbing is stagnation in the formation of new firms. Statistics from the Bureau of Labor Statistics (BLS) show that the number of establishments in operation for less than one year rose between the mid-1990s, when the data start, and the early 2000s. But, smoothing through the ups and downs of the business cycle, new firm formation has been roughly flat since then. Moreover, the number of individuals working at such firms stands almost 2 million below its peak in 1999. Given the role of innovation by entrepreneurs and the well-documented importance of successful young firms in creating jobs, these trends are disheartening.

Although the Federal Reserve, like other forecasters, has tended to be overoptimistic in its forecasts of real GDP during this recovery, we have also, at times, been too pessimistic in our forecasts of the unemployment rate. For example, over the past year unemployment has declined notably more quickly than we or other forecasters expected, even as GDP growth was moderately lower than expected a year ago. This discrepancy reflects a number of factors, including declines in participation, but an important reason is the slow growth of productivity during this recovery; intuitively, when productivity gains are limited, firms need more workers even if demand is growing slowly. Disappointing productivity growth accordingly must be added to the list of reasons that economic growth has been slower than hoped.17 (Incidentally, the slow pace of productivity gains early in the recovery was not evident until well after the fact because of large data revisions--an illustration of the frustrations of real-time policymaking.) The reasons for weak productivity growth are not entirely clear: It may be a result of the severity of the financial crisis, for example, if tight credit conditions have inhibited innovation, productivity-improving investments, and the formation of new firms; or it may simply reflect slow growth in sales, which have led firms to use capital and labor less intensively, or even mismeasurement. Notably, productivity growth has also flagged in a number of foreign economies that were hard-hit by the financial crisis. Yet another possibility is weak productivity growth reflects longer-term trends largely unrelated to the recession. Obviously, the resolution of the productivity puzzle will be important in shaping our expectations for longer-term growth.

By the same token, it's hard to believe productivity has hit some sort of plateau. It doesn't take much digging to find examples of continued innovation in today's economy, even if it hasn't generated the rapid aggregate productivity growth we saw during the Great Moderation. The most likely outcome, in my view, is more of the same, and thus my outlook is that productivity growth will be about 1 percent for a considerable period.

Starting first with productivity: From 1983 to 2000, productivity grew at a 1.8 percent annual rate. But toward the end of the Great Moderation, productivity growth slowed, and over the last three years, productivity has increased at a very modest 1.0 percent annual rate. Forecasting trends in productivity growth is exceedingly difficult. Having said that, it's hard to see why productivity growth would improve dramatically in the near term; there's no sign of a major surge of technical innovation in the pipeline, significant educational improvement or substantial deregulation the kind of developments that would lead to a major acceleration in productivity. By the same token, it's hard to believe productivity has hit some sort of plateau. It doesn't take much digging to find examples of continued innovation in today's economy, even if it hasn't generated the rapid aggregate productivity growth we saw during the Great Moderation. The most likely outcome, in my view, is more of the same, and thus my outlook is that productivity growth will be about 1 percent for a considerable period.

Since the early 2000s, however, the job reallocation rate has slowed...

Interpreting this apparent loss of dynamism across firms is not straightforward. It could be that these slowing dynamics are not a bad thing if we get the same growth of productivity we've enjoyed in the past without so much churning of jobs. But that doesn't quite fit with the low productivity growth we've experienced during this recovery.

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The likely direction of productivity measures in our economy is the subject of considerable debate. Another, more concerning possibility is that the slow advance of productivity reflects a fundamentally less dynamic economy.

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The question I posed at the outset was whether the economic dynamism of the United States is declining. Is America losing its economic mojo? There is some evidence to the affirmative. I believe some of what we observe can be explained by the recent recession and frustratingly slow recovery. There are reasons to believe that some of the decline is cyclical in nature and will reverse itself over time.

Economic policy affects innovation and long-run economic growth in many ways. A stable macroeconomic environment; sound public finances; and well-functioning financial, labor, and product markets all support innovation, entrepreneurship, and growth, as do effective tax, trade, and regulatory policies.

Output per hour, or productivity, is the secret sauce to U.S. economic growth and to rising living standards, but I fear that the recipe may have lost some key ingredients. Growth in labor productivity arises when a firm's workers use more and better physical capital, or when firms become more efficient at converting inputs into output. Innovation plays a key role, both because it directly boosts efficiency and because firms' decisions to invest in physical capital tend to depend on the underlying pace of innovation. In addition, in today's economy, the productivity of many firms relies heavily on intangible, or intellectual, capital; although hard to measure, intangible capital appears to also be tied to innovation.