(Archived Content)
Alan B. Krueger
Assistant Secretary for Economic Policy & Chief Economist
The U.S. economy continues to recover from the deepest and longest recession since the end of World War II. Real GDP continues to expand, consumer spending is growing steadily at a moderate pace, business investment is rising, and firms are adding workers to their payrolls. More than 850,000 private-sector jobs, on net, have been added so far this year. Nevertheless, the unemployment rate remains elevated at 9.6 percent. The subpar labor market performance is weighing on the housing market, which, although still weak, is generally more stable than a year ago. Conditions in financial and credit markets have improved in recent months, following an uptick in volatility related to developments in European debt markets during the spring. The improvement in the economy over the past year has led to improvement in U.S. government finances. The federal budget deficit narrowed to 8.9 percent of GDP in FY2010 from 10 percent of GDP in FY2009, and is expected shrink significantly further in the next few years as the recovery gains momentum. Private forecasters generally expect another moderate increase in real GDP in Q4, and see growth strengthening in 2011.
In 2010Q3, real GDP increased 2 percent, powered by solid growth of consumer spending and business investment and a pickup in inventory accumulation. Residential investment fell, however, and the net export deficit widened as imports rose faster than exports. Both of those developments were negative for Q3 growth: the drop in residential spending subtracted 0.8 percentage point and the larger trade deficit reduced growth by 2 percentage points. Still, private domestic final demand (the sum of consumer spending and private fixed investment) grew by 2.3 percent in Q3, down from 4.5 percent in Q2 but still a sturdy gain. Since the current expansion began in mid 2009, real GDP has risen by 3.5 percent, recouping about 85 percent of the 4.1 percent drop in output that occurred during the recession.
The 2010Q3 decline in residential investment followed a similarly-sized rise in 2010Q2, with the swings largely due to the April 30th expiration of the home buyer tax credit. The tax incentive boosted sales commissions and home building sharply in the months prior to its expiration, essentially pulling activity forward in time. After the tax credit expired, housing starts and home sales slowed considerably; more recently they have started to recover. In September, housing starts returned to their early 2010 levels. Home sales rose in August and September after posting very sharp declines in July, but overall remain at very low levels. At about a 10 month supply, the inventory of homes on the market is still high relative to sales. Despite the sharp swings in housing activity this year, home prices have been generally stable. During the first eight months of the year, the S&P Case-Shiller 20 city house price index edged up almost 1 percent, after falling almost 4 percent during the first eight months of 2009. Further recovery in prices and the housing market more generally will likely remain muted in the near term given the high level of unemployment, the large stock of homes available for sale, uncertainty over foreclosure procedures, and the volume of mortgages facing or already in foreclosure.
The labor market continues to recover, but unemployment remains high. According to the monthly payroll survey, private-sector employment has grown steadily since the end of 2009, with 863,000 workers added, on net, to payrolls in the first nine months of this year. During the same period last year, the economy lost nearly 4.4 million private-sector jobs. The household survey – which uses a broader definition of employment that includes self-employed workers – shows about twice as much job growth over the first nine months of 2010, with household employment rising by 1.6 million so far this year. While these gains are encouraging, the extent of joblessness remains a serious concern. The unemployment rate currently stands at 9.6 percent, with roughly 14.8 million people unemployed and another 12 million under-employed in some way. The extent of long-term unemployment has been unusually severe during the recession and the recovery so far, although the share of unemployed workers who have been without a job for 27 weeks or longer has edged down from a high of 46 percent in May to 41.7 percent in September.
The large degree of slack in labor markets and the low level of capacity utilization have helped keep a lid on inflation. Headline consumer prices rose a moderate 1.1 percent over the twelve months ending in September, and core consumer prices were up just 0.8 percent. That was the smallest year-over-year increase in the core since 1961. Wage pressures remain modest. The Employment Cost Index (ECI) for private-industry workers rose 1.9 percent over the year ending in September. Recent quarterly increases in this measure are among the smallest in the 30-year history of the data series.
Volatility in financial markets has declined since June, and equity markets continue to recover from their mid-spring slide. The S&P 500 has not yet returned to the near-term high reached in late April, before European sovereign debt issues emerged, but it is up about 6 percent so far this year and has increased more than 70 percent from its March 2009 low. Spreads between Baa-rated corporate bonds and the 10-year Treasury note remain elevated (at about 300 basis points), but are well below late 2008 levels (which were about 600 basis points). Conventional mortgage rates remain near record lows, providing some support for housing demand and helping consumers restructure their balance sheets through mortgage refinancing.
Partly as a result of improving economic and financial conditions, the federal budget deficit narrowed to $1.3 trillion (8.9 percent of GDP) in FY2010 from $1.4 trillion (10 percent of GDP) in FY2009. The deficit is expected to decline significantly further over the next few years, falling to between 5.5 percent and 6 percent of GDP in FY2012 as the economy improves and Recovery Act provisions expire. Proposals made in the FY2011 budget would trim the deficit further, to an average between 3.5 percent and 4 percent of GDP between FY2015 and FY2020.
Despite the improvement over the past 15 months, it is important to take steps to ensure that the recovery is sustained and becomes a long-term expansion. Chief among the current challenges is the high level of unemployment. The Administration continues to seek ways to lower the unemployment rate and reinforce the recovery. In late September, the President signed the Small Business Jobs Act, which includes a set of tax cuts and lending incentives to spur hiring and growth at small businesses. Small business start-ups are one of the main reasons the U.S. economy is dynamic and resilient. These businesses were hit particularly hard during the financial crisis, and encouraging their growth is essential to a robust recovery. The Small Business Lending Fund seeks to provide support for community banks to provide loans to this critical sector. Further, in August, the Administration and Congress gave state and local governments an additional $10 billion that will save over 160,000 teacher jobs, and extended the Federal Medical Assistance Percentages (FMAP) program that provides an additional $16.1 billion to ease the burden of Medicaid on state budgets.
More recently, the President proposed three new initiatives: $50 billion in accelerated infrastructure spending on roads, bridges, railways and airports; allowing all businesses to write off 100 percent of the cost of capital equipment purchased through 2011; and expanding and making permanent the tax credit for research and experimentation. These policies are targeted at current areas of weakness, but they are also good for the long-term health of the economy. For example, increased infrastructure spending will help make the economy more productive and provide for a rising standard of living. The proposal to allow corporations to write off 100 percent of their spending on new equipment through the end of 2011 will help to increase private productive capital, which will improve our long-term growth prospects and provide an incentive for firms to buy capital equipment now to strengthen the recovery in the near term.
In sum, the economy is healing and the expansion is expected to strengthen. However, risks remain. Recoveries do not move in straight lines, but with the right policies, we can lay the foundation for faster growth and stronger employment gains going forward.
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