Category Archives: The Economic Crisis

The Sluggish Recovery: Fiscal Drag Continues to Hold Back the Economy

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Recessions - GDP Around Peak, 12Q before to 22Q after

I.  Introduction

The recovery from the 2008 economic collapse remains sluggish, with GDP growing in the first half of 2013 at an annualized rate of only 1.4% (according to recently released BEA estimates).  And based on fourth quarter to fourth quarter figures, GDP grew by only 2.0% in 2011 followed by just 2.0% again in 2012.  As a result, the unemployment rate has come down only slowly, from a peak of 10.0% in 2009 to a still high 7.4% as of July.

Conservatives have asserted that the recovery has been slow due to huge and unprecedented increases in government spending during Obama’s term, and that the answer should therefore be to cut that spending.  But as has been noted in earlier posts on this blog, direct government spending during Obama’s term has instead been falling.  This reduction in demand for what the economy can produce has slowed the recovery from what it would have been.

This blog will update numbers first presented in a March 2012 post on this blog, which compared the paths of GDP, government spending, and other items in the periods before and after the start of each of the recessions the US has faced since the 1970s.  That earlier blog post looked at the paths of GDP and the other items from 12 quarters before the business cycle peak (as dated by the NBER, the entity that organizes a panel of experts to date economic downturns) to 16 quarters after those peaks (when the downturns by definition begin).  The figures were rebased to equal 100.0 at the business cycle peaks.  We now have an additional year and a half of GDP account data, so it is now possible to extend the paths to 22 quarters from the start of the recent downturn in December 2007.  This has therefore been done for all.

The conclusions from the earlier post unfortunately remain, but are even more clear with the additional year and a half of observations.  GDP growth remains sluggish, government spending has fallen by even more, and residential investment remains depressed (although it has finally begun to recover).

II.  The Path of Real GDP

The graph at the top of this post shows the path followed by real GDP in the periods from 12 quarters before to 22 quarters after the onset dates of each of the recessions the US has faced since the 1970s.  The sluggish recovery from the current downturn is clear.

The economy fell sharply in the final year of the Bush administration, and then stabilized quickly after Obama took office.  GDP then began to grow from the third quarter of 2009 and has continued to grow since.  But the pace of recovery has been slow.  By 22 quarters from the previous business cycle peak, real GDP in the current downturn is only 4% above where it had been at that peak.  At the same point in the other downturns since the 1970s, real GDP was between 15% and 20% above where it had been at the previous peak.  This has been a terrible recovery.

 III.  The Path of Government Spending

How has this recovery differed from the others?  To start to understand this, look at the path government spending has taken:

Recessions - Govt Cons + Inv Expenditures Around Peak, 12Q before to 22Q after

Direct government spending has fallen in this recovery, in sharp contrast to the increases seen in the other recoveries.  Real government spending was 26% higher by 22 quarters after the onset of the July 1981 recession (the green line) during the Reagan presidency, and 13% higher at the same point in the recovery from the March 2001 recession (the plum colored line) during the Bush II presidency.  While both Reagan and Bush claimed to represent small government conservatism, government spending instead rose sharply during their terms.

In contrast, in the current downturn direct government spending is now 1.2% below what it had been at the start of the recession in December 2007.  Furthermore, it is worth noting that while it rose in the final year of the Bush presidency and then in the first half year after Obama took office (a major reason why the recovery then began), it has since fallen sharply.  Government spending is now almost 7% below where it had been in mid-2009, a half year after Obama took office.  Such a decline (indeed no decline) has ever happened before, going back at least four decades, as the economy has struggled to recover from a recession.  The closest was during the Clinton years, when government spending was essentially flat (a 1% increase at the same point in the recovery).

Note that the measure of government spending shown here is that for total government spending on consumption and investment (i.e. all government spending on goods and services).  This is the direct component of GDP.  Government spending can also be measured by including transfer payments to households (such as for Social Security or unemployment insurance), but as was noted in the earlier blog post from March 2012, the results are similar.  Note also that the government spending figures include spending at the state and local levels, in addition to federal spending.  While we speak of government spending as taking place during some presidential term in office, the decisions are made not simply by the president but also by many others (including state and local officials, and the Congress) in the US system.  But the president at the time is typically assigned the blame (or the credit) for the outcome.

IV.  The Path of Residential Investment

The current downturn and recovery also differs from the others by the scale of the housing collapse, and consequent fall in residential investment:

Recessions - Residential Investment Around Peaks, 12Q before to 22Q after

The build up of the housing bubble from 2002 to 2006 was unprecedented in the US, and the collapse then more severe.  As the graph above shows, there has been a start in the recovery of residential investment from the lows it had reached in 2009 / 2010, but it is still far below the levels seen in previous downturns.

Housing had been overbuilt during the bubble in the Bush years, leaving an oversupply of housing once the bubble burst.  And while supply was in excess, demand for housing was reduced due to the severe recession.  As was discussed in an earlier blog post on the housing crisis, the result was a doubling up of households as well as delays in household formation as young adults continued to live with their parents.  Residential investment therefore collapsed, and has recovered only very slowly.

V.  The Path of Household Debt

The housing bubble also led to over-indebtedness of households.  Nothing of this sort at all close to this scale had ever happened before in the US.  With the lack of regulation and oversight of the financial sector during the Bush administration, banks and other financial entities launched and aggressively marketed and sold financial instruments that led to a bidding up of home prices.  But these new financial instruments were only viable if housing prices continued to rise forever.  When the housing bubble burst, widespread defaults followed.  And those households who did not default struggled to pay down the debts they had taken on, for assets now worth less than the size of the debts tied to them.

The result was a sustained fall in household debt (three-quarters of which is mortgage debt) in the period of the downturn:

Recessions - HH Debt Around Peak, 12Q before to 22Q after

This pay-down of debt had never happened before, and is in stark contrast to the rise in household debt seen in all the other downturns of the last four decades.

VI.  The Path of Personal Consumption Expenditure

Households struggling to pay down their debt have to cut back on their consumption expenditures.  This brings us to the last element of the current recovery I would like to highlight:  the especially slow recovery in household consumption.  That path of consumption during the current downturn stands out again in contrast to the paths followed in the other downturns and recoveries of the last four decades in the US:

Recessions - Personal Consumption Around Peaks, 12Q before to 22Q after

The difference is stark.  Households could spend more in the prior recoveries in part because they could continue to borrow (see the graph on household debt above).  In this recovery, households have instead had to pay down the debts they had accumulated in the housing bubble years, and could increase their household consumption only modestly.

VII.  Conclusion

The recovery in the current downturn has been disappointing.  GDP has grown since soon after Obama took office, but has grown only slowly, and has been on a path well below that seen in other recoveries.

There are a number of reasons for this.  Household consumption has kept to a low path as households have struggled to repay the over-indebtedness they had accumulated during the housing bubble years.  Residential investment collapsed as well following the bubble, is only now starting to recover, and remains far below the levels seen at similar points in other recoveries.
And government spending has been allowed to fall during Obama’s term.  This had never happened before in the previous downturns.  Indeed, while real government spending rose by 26% at the same point in the economic recovery during the Reagan presidency, it has been reduced by over 1% in this recovery (and reduced by 7% from what it had been a half year after Obama took office).
The reduction in government spending reduced the demand for what the economy could have produced.  In this it was similar to the reduced demand resulting from lower residential investment or lower household consumption expenditure.  All these reductions in demand reduced GDP, reduced the demand for workers, and hence increased unemployment.  But while residential investment and household consumption can only be influenced indirectly and highly imperfectly by government policy, government has direct control over how much it spends.  That is, government can decide whether to build a road or a school building, and doing so will employ workers and will lead to an increase in GDP.  Hence government spending is a direct instrument that can be used to raise growth and employment, should the government so choose.
Sadly, and in stark contrast to the sharp increase in government spending during the Reagan period that spurred the recovery to the 1981 downturn, US politics during the Obama presidency have instead led to a cut-back in government spending, with a resulting drag on growth.  The disappointing consequences are clear.

Eurozone Unemployment at Record High: The Consequence of Austerity Programs

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Eurozone Unemployment Rate, Dec 2007 to March 2013

As reported in the recent release from Eurostat, Eurozone unemployment rose again in March to a record 12.1%.  This is the highest rate ever for the Eurozone, and indeed the highest rate since at least 1983 (the earliest date for unemployment data reported by Eurostat) for the underlying countries.

Austerity programs do increase unemployment, despite what senior European officials have said.  On this, one might recall the famous assertion in June 2010 of Jean-Claude Trichet, then head of the European Central Bank, that austerity programs would be expansionary and lead to job creation.  As was discussed in an earlier post on this blog, in a June 2010 interview with La Repubblica (the largest circulation newspaper in Italy), Trichet said:

Trichet:  … As regards the economy, the idea that austerity measures could trigger stagnation is incorrect.

La Republicca:  Incorrect?

Trichet:  Yes …

And in an interview a month later in the newspaper Libération of France:

Libération:  Do the austerity plans announced amid monumental disarray by the Member States pose the risk of killing off the first green shoots of growth?

Trichet:  It is an error to think that fiscal austerity is a threat to growth and job creation. …

At the urging of Trichet, other European officials, and especially German government officials, most of Europe then began to reverse the stimulus programs of late 2008 and 2009  –  programs that had stopped and then reversed the free fall resulting from the 2008 economic and financial collapse.

Exactly one year after Trichet made his famous assertion, unemployment rates in the Eurozone began a steady upward march, which have continued ever since.

Europe GDP Falls Again: Austerity Programs Lead to Contraction

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Europe GDP Growth, 2007Q4 to 2012Q4

The European Statistical Agency Eurostat released today its “flash” estimate of GDP growth in the European economies in the fourth quarter of 2012.  The results are terrible.  The initial estimate is that GDP fell at a seasonally adjusted annualized rate of 2.4% in the fourth quarter (or a fall of 0.6% quarter on quarter) in the 17 economies that make up the Eurozone, and that GDP fell at an annualized rate of 2.0% (0.5% quarter on quarter) in the 27 economies in the European Union as a whole.  The 2.4% rate of fall of GDP in the Eurozone, and fall of 2.0% in the EU as a whole, can be contrasted with the recently released estimate that GDP in the US was essentially flat (a 0.1% rate of decline in the initial estimate) in the fourth quarter of 2012.

The flat GDP in the US at the end of 2012 was not a good performance, and has been justly criticized as well below what is needed.  But the fall at a rate of 2.4% in the Eurozone was far worse.  As shown in the graph above, Eurozone GDP has now fallen steadily for five quarters in a row.  Europe is well into a double-dip recession, having never fully recovered from the 2008 downturn, and its GDP is now 3% below what it was in the first quarter of 2008, almost five years ago.

Not only is output falling in Europe as a whole, but it is also falling in each of the major countries.  Especially notable is the fall in GDP at an annualized rate of 2.4% in Germany.  GDP in Germany had been rising at a modest rate since mid-2009, although the recovery slowed in 2011 and has now turned negative.  But in addition to Germany, there were falls in GDP at annualized rates of 1.2% in France and the UK, of 0.8% in the Netherlands, and also of 2.8% in Spain and 3.6% in Italy (not shown in the graph above).

UK output is now even further below the path it followed during the Great Depression in the 1930’s.  As discussed in an earlier posting on this blog, the UK economy is performing worse now than it did during the Great Depression.  The turnaround from what had been a modest but steady recovery occurred in mid-2010, when the newly elected Conservative-led government embarked on an austerity plan similar to what Republicans have called for the US to follow.  But the consequences have been terrible.  By 19 quarters into the downturn (one quarter shy of five years), the UK economy is producing 3% less than it had in early 2008.  At the same point during the Great Depression, the UK economy was producing 4% more than at its previous cyclical peak, and growth was steadily positive.

The fall in German GDP is significant, as it may now induce Germany to agree to steps that would allow Europe as a whole to recover and start to grow.  Germany has been a forceful advocate for austerity in both fiscal and monetary programs, even though (as discussed in an earlier posting on this blog), Germany itself had until 2011 had its government expenditures grow relatively strongly.  But its economy slowed in late 2011 and into 2012, and output has now fallen sharply in the last quarter of 2012.  Germany has strongly resisted measures which would have served to boost European growth, but there may now be a basis for the hope that this will change, now that Germany sees its interests aligned with those of others in Europe.

There are steps that Europe could take to recover from this downturn.  These include:

  1. Reverse the austerity policies, at least among the economies with ready access to the financial markets.  Ten year government borrowing rates are only 1.5% in Germany, 1.7% in the Netherlands, 1.8% in the UK, and 2.2% in France.  These are either below, or close to, the 2% inflation target of the ECB and others.  That is, these governments can borrow ten year funds at essentially zero or even negative real cost.  It is madness not to make use of such funds to pay for investments in infrastructure, education, and other purposes, at a time when resources (both labor and capital) are idle due to lack of demand.  Indeed, it is in times like these when such public investments are best made.  Not only do they boost the recovery, but they do not displace the use of such resources for other purposes.  When the economy is close to full employment, with capital also being fully utilized, using resources for infrastructure and other public investments entails a trade-off, as the resources then used for such public investment have to be drawn from their use for other purposes.  The trade-off might then still be warranted, but it is far better to make such public investments in times like today, when there is no such trade-off.
  2. The European Central Bank should follow the more supportive monetary policies that have been followed by all the other major central banks in the world, including in the US, the UK, and Japan.  The main policy interest rates at all these other central banks have been kept at 25 basis points (0.25%) or below since their economies started crashing in late 2008.  The European Central Bank, in contrast, kept its main policy interest rate at 100 basis points from May 2009 to April 2011.  This relatively high rate at a time of economic weakness led to greater economic weakness, as shown in the graph above.  It then made the mistake of starting to raise the rate, first to 125bp and then to 150bp in the spring and summer of 2011.  The renewed downturn in GDP of the Euro 17 started soon thereafter (see the graph above).  The ECB then started to lower the rate again in late 2011, but it was too little and too late. And the policy rate remains (since mid-2012) at 75bp, well above the rates followed by the other major central banks of the world.  The ECB should lower its rate to 25bp immediately.
  3. Weakness in the commercial banking system in Europe remains a major problem, particularly as financial markets in Europe are far more dependent on their commercial banking systems than is the case in the US (where capital markets are relatively larger).  When the euro was under intense pressure last summer, European leaders agreed to move to some form of a system of more centralized commercial bank regulation and supervision.  But while an important agreement was reached in December 2012, under which the European Central Bank would supervise directly the larger banks in Europe, this agreement did not go as far as had been earlier anticipated.  While it was agreed that the ECB would have direct responsibility for the supervision of the major banks, its authority to deal with failing banks and the resources it could use to do so, were kept limited.  There is also no central system of deposit insurance, but rather still a set of different systems at the national level.  A euro-wide system of bank regulation and supervision, with the power and resources to address failing banks and with a consolidated deposit insurance system, would go far to addressing the weaknesses of a common currency zone.  In a common currency zone, the ability of national authorities to deal with failing banks is constrained.

Europe is now in a double-dip recession.  The austerity programs have failed.  Yet Republicans in the US continue to push for the US to follow similar policies.