The U.S. Economic Recovery: Why so weak and what should be done? William J. Crowder Ph.D.
Weak Recovery? It s no secret that the U.S. economy has still not fully recovered from the financial crisis and subsequent recession. The economic expansion following the 2007 recession has been the weakest of the post World War II era and remains an outlier among postwar recoveries along several dimensions.
Real GDP Growth Cumulative Change in Real GDP from Peak 30% 25% 20% 15% 10% 5% 0% -5% 2 4 6 8 10 12 14 16 18 20 Quarters After Peak 1948 1953 1957 1960 1969 1973 1980 1981 1990 2001 2007
20 15 10 5 0-5 Real GDP Growth 2 4 6 8 10 12 14 16 18 20 Quarters After Peak AVG 2007 Cumulative Change in Real GDP from Peak
20 16 12 8 4 0-4 Real GDP Growth 2 4 6 8 10 12 14 16 18 20 Quarters After Peak 1990 2001 AVG Cumulative Change in Real GDP from Peak
The Deeper the Plunge -5-4 * 2007 1957 Depth of Recession -3-2 -1 1980 1953 1990 1973 1981 1960 1948 0 1969 2001 1 0 5 10 15 20 25 30 4YearCumulative GDP Growth
Recoveries Following Financial Crises Source: John Taylor, http://economicsone.com/
The Labor Market Story is Just as Bad 10 8 6 4 2 0-2 5 10 15 20 25 30 35 40 45 4 Year Employment Growth Average of 10 Previous Recoveries 4 Year Employment Growth since June 2009
% of Population Employed
Well Below Potential
Why So Bad This Time? Housing Wealth Decline Lower Government Spending Weak Investment Spending
Why So Bad This Time? Housing Wealth Decline Lower Government Spending Weak Investment Spending
The Housing Market 6.4 6.0 5.6 5.2 4.8 4.4 4.0 1975 1980 1985 1990 1995 2000 2005 2010 Trend Housing Price Housing Price Index (log scale)
Household Consumption 9.6 9.4 9.2 9.0 8.8 8.6 8.4 8.2 8.0 1975 1980 1985 1990 1995 2000 2005 2010 Real Personal Consumption (log scale) Trend Consumption 1973-2007
The Housing Market Case-Shiller Home Price Index 220 200 180 160 140 120 100 80 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Date
Why So Bad This Time? Housing Wealth Decline Lower Government Spending Weak Investment Spending
Federal Government Purchases of Goods and Services.22.21.20.19.18.17.16.15 1975 1980 1985 1990 1995 2000 2005 2010 Federal Gov't Purchases as Percentage of GDP Trend in Federal Purchases (1975-2012)
Federal Government Transfer Payments.16.15.14.13.12.11.10.09.08.07 1975 1980 1985 1990 1995 2000 2005 2010 Federal Gov't Transfers as Percentage of GDP Trend in Federal Transfers (1975-2012)
Federal Government Interest Payments.050.045.040.035.030.025.020 1975 1980 1985 1990 1995 2000 2005 2010 Federal Gov't Interest Payments as Percentage of GDP Trend in Federal Interest Payments (1975-2012)
When Interest Rates Rise 900 800 700 600 500 400 300 200 100 0 1975 1980 1985 1990 1995 2000 2005 2010 Interest Payments on Federal Debt if Average Interest Rate is 5% Actual Interest Payments on Federal Debt
Why So Bad This Time? Housing Wealth Decline Lower Government Spending Weak Investment Spending
Investment Spending 8.4 8.0 7.6 7.2 6.8 6.4 6.0 5.6 5.2 50 55 60 65 70 75 80 85 90 95 00 05 10 Real Gross Private Domestic Investment (log scale) Trend Investment (1975-2007)
How Important is Investment?
Household Consumption 9.6 9.4 9.2 9.0 8.8 8.6 8.4 8.2 8.0 1975 1980 1985 1990 1995 2000 2005 2010 Real Personal Consumption (log scale) Trend Consumption 1973-2007
Non-Durable Consumption.84.82 % of Disposable Income.80.78.76.74.72.70 1975 1980 1985 1990 1995 2000 2005 2010 Trend in Non-Durables plus Services Consumption Relative to Disposable Income Consumption Spending on Non-Durables and Services Relative to Disposable Income
Consumption of Durables.14.13 % of Disposable Income.12.11.10.09 1975 1980 1985 1990 1995 2000 2005 2010 Average Durables Consumption Relative to Disposable Income Consumption Spending on Durables Relative to Disposable Income
What Role for Monetary Policy? The Taylor rule Proposed by Stanford Economics Professor John Taylor and specifies an optimal rule for setting the Fed s federal funds rate target. Such policy rules alleviate the time inconsistency problem.
The Taylor Rule 20 16 12 8 4 0-4 1975 1980 1985 1990 1995 2000 2005 2010 Taylor Rule Interest Rate Actual Federal Funds Interest Rate
What Role for Monetary Policy? The money supply depends on three factors Currency holdings by the public, c. Excess reserve holdings by banks, e. The Fed s supply of base money through open market operations, MB.
What Role for Monetary Policy? When the public decides to hold more of its money in currency rather than in deposits the overall money supply shrinks. When banks hold more of their excess reserves rather than lend them out, the money supply shrinks.
Some Historical Perspective
Excess Reserves Ratio and Currency Ratio, 1929 1933
M1 and the Monetary Base, 1929 1933
Excess Reserves Ratio and Currency Ratio, 2007-2009
M1 and the Monetary Base, 2007-2009
Deflation v. Inflation When the money supply is allowed to decrease, the result is deflation. Prices actually begin to fall over time. Deflation is much more pernicious than inflation. If the Fed errs, it will be on the side of inflation.
Low Interest Rates The historically low interest rates not only helps counteract deflation but also encourages intertemporal substitution by households. By making current consumption cheap relative to future consumption, the Fed is distorting the decision making of households away from the future and towards the present
Optimal Consumption Consumption tomorrow C 2 -(1+r) IC 0 C 1 Consumption today
Fed Lowers Interest Rate to Increase Current Consumption Consumption tomorrow C 2 -(1+r) IC 2 0 C 1 Consumption today
Credit Constrained Households Consumption tomorrow 0 Consumption today
Three Structural Challenges NICs and the globalization of the labor market Deficits and demographics Technology and labor
Three Structural Challenges NICs and the globalization of the labor market Deficits and demographics Technology and labor
Three Structural Challenges NICs and the globalization of the labor market Deficits and demographics Technology and labor
Three Structural Challenges NICs and the globalization of the labor market Deficits and demographics Technology and labor