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Acting Assistant Secretary for Economic Policy Ralph M. Monaco Statement for the Treasury Borrowing Advisory Committee Of the Securities Industry and Financial Markets Association February 2, 2009

(Archived Content)




Economic activity slowed sharply in the final few months of 2008, reflecting the combined effects of the ongoing retrenchment in homebuilding activity and the additional downdraft from the severe tightening in credit markets that began in mid-September.   The labor market deteriorated notably, with unemployment hitting a 16-year high at the end of 2008.   Headline inflation dropped, led by a rapid decline in crude oil and gasoline prices.   Although stock market indexes dropped significantly in the final few months of 2008, credit conditions showed some signs of improvement very late in 2008 and in early 2009.   In early December 2008, the National Bureau of Economic Research designated December 2007 as the beginning of the 11 th postwar recession.

The economy contracted significantly in the fourth quarter.   Real GDP fell by 3.8 percent at an annual rate – the largest quarterly decline since early 1982.   Consumer spending plunged for a second straight quarter, falling by 3.5 percent.   Business spending on plant and equipment plunged 19 percent as outlays for structures declined for the first time in 3 years and spending on equipment and software posted the largest quarterly drop since 1958.   Residential investment tumbled by about 24 percent, subtracting 0.8 percentage point from GDP growth.   Exports and imports both fell sharply but net exports declined only slightly and were essentially neutral for real GDP after adding roughly 1-1/2 percentage points on average to growth in the previous six quarters.   The economy received modest support from government spending and a much bigger boost from a pickup in inventory investment, which added 1.3 percentage points to the fourth-quarter growth rate. Excluding the change in inventories, real final sales of domestic product fell 5.1 percent on top of a 1.3 percent decline in the third quarter.  Private forecasters anticipate another significant decline in real GDP in the first quarter of 2009, but some pickup in the second half of the year.

Job losses accelerated and the unemployment rate jumped higher at the end of the year.   December marked the twelfth straight month of job losses with 524,000 workers cut from nonfarm payrolls.   That brought the total job loss since December 2007 to 2.6 million with 1.5 million lost since September.   The unemployment rate jumped 0.4 percentage point to a 16-year high of 7.2 percent in December.   Including workers who are underemployed and those who are only marginally attached to the labor force, the unemployment rate was 13.5 percent – a record high for this measure which dates back to 1994.   Private forecasters see the unemployment rate continuing to rise through most of 2009.

Much of the weakness in the overall economy stems from the continued adjustment in the housing market.   Homebuilder sentiment reached a record low in early 2009.   Housing starts fell 45 percent during 2008, and new and existing home sales fell almost 7 percent during the 12 months of 2008.   Inventories of unsold homes are shrinking, but relative to sales remain at very high levels, which continue to put downward pressure on home prices.   Measured by the S&P/Case-Shiller 20 city index, home prices were down 18 percent in the year ended in November 2008.

Falling house prices have contributed to the weakness in consumer spending.   House price declines have eroded the value of household real estate holdings while equity market declines have reduced the value of many financial assets.   Household net worth posted a record decline in the third quarter, bringing the total loss since its peak in the third quarter of 2007 to $7.1 trillion and pulling net worth back to late 2005 levels.   Household debt outstanding fell in the third quarter for the first time since the early 1950s, and consumer borrowing declined in October and November.   Given declining home prices and the sharp stock market declines, it is clear that household wealth continued to shrink in the fourth quarter.  This all contributes to the downdraft in consumer spending.  Declining wealth, a pullback in borrowing and the weak job market all suggest that consumer spending will remain sluggish in the first half of 2009.  

Falling energy prices have provided some relief to households in recent months.   Retail gasoline prices have declined by roughly $2.25 from the all-time high of $4.11 per gallon recorded in July and now stand at $1.84 per gallon – a level not seen since early 1994.   The benchmark one-month futures price of West Texas Intermediate crude oil has declined more than 70 percent from a record intraday high of $147 per barrel in mid July to roughly $42 per barrel.  

The retreat in energy prices has contributed to a pronounced moderation in headline inflation.   Consumer prices rose at a 5.5 percent annual rate in the first half of 2008, and dropped 5.4 percent at an annual rate in the second half of the year.    For the entire year, consumer prices rose just 0.1 percent, the smallest annual increase since 1955.   Core consumer inflation (excluding food and energy prices) has also eased.   Core inflation was just 1.8 percent in 2008, down from 2.4 percent during the twelve months of 2007.   The weakening economy helped to hold core inflation in check in the second half of 2008, a trend that appears likely to continue in the first half of 2009.

Financial and credit markets remain fragile, further clouding the economic outlook for early 2009.   Equity markets posted steep losses last year, triggered by growing weakness in the U.S. economy and concerns about the performance and viability of a wide range of financial assets, as well as the financial institutions holding or providing contingent guarantees for those assets.   The S&P 500 plunged 38 percent during 2008 – the largest annual loss since the 1930s – and was down by an additional 8.6 percent through January 30.   The S&P stock market volatility index (VIX), often used as a measure of financial market uncertainty, has retreated from the all-time high of almost 81 percent posted on November 20, 2008 but at roughly 42 percent remains well above readings near 20 percent in late August of 2008.  

Credit market conditions have started to improve but have not yet returned to their mid 2007 pre-crisis levels.   The LIBOR-OIS spread – a measure of what banks perceive as the credit risk in lending to one another – has eased substantially.   It is currently hovering around 95 basis points, down from a high of 365 basis points in early October but still significantly wider than the roughly 9 basis point spread that prevailed prior to mid 2007.   Likewise, rates on lower-rated commercial paper have fallen after spiking in late September.  

Corporate lending and the flow of credit from banks remains constrained, however.   The Baa corporate bond rate is roughly 550 basis points above the 10-year Treasury rate, an improvement compared to the spread of 616 basis points recorded in early December but still very high by historical standards.   Surveys of bank officers suggest that banks have become much less willing to make both consumer and business loans.  

It will take considerable time to work through the many problems our economy currently faces.   A number of measures have already been taken as part of the Emergency Economic Stabilization Act (EESA) of 2008 that was enacted in early October.   The Capital Purchase Program has allocated nearly $195 billion in funds from the Troubled Asset Relief Program (TARP) to a broad array of financial institutions.   Several additional programs have also been put in place to help normalize credit markets and prevent disruption in financial markets and the broader economy.                                      

The Administration recognizes that more can be done and is now hard at work to enact legislation to jumpstart job creation and put the economy back on a path towards long-term growth.  

Measures to support the economy coupled with lower revenues as a consequence of the recession are raising the deficit.   In FY2008, the Federal budget deficit widened by $292 billion to $455 billion (3.2 percent of GDP).   The budget deficit will continue to grow in FY2009 as expenditures rise sharply and receipts are depressed by falling employment and income and declining asset values.   Outlays to support financial markets and stimulate the economy are expected to push the federal deficit to a record level in FY2009, both in absolute terms and as a share of GDP.   In early January, the Congressional Budget Office estimated that the deficit in FY2009 will top $1.2 trillion, more than 8 percent of GDP.   Despite the considerable budgetary cost of these measures, they are necessary to avoid even far greater losses in jobs and income than have already occurred.  

In sum, the economy is currently experiencing one of the longest periods of recession in the post-war period.   While it will take time for conditions to improve, efforts already underway to restore stability in financial and credit markets, together with a new injection of fiscal stimulus will put the U.S. economy firmly back on the path towards long-term, sustainable growth.