High Unemployment and Economic Stagnation: The New U.S. Status Quo?
This Wednesday, the Department of Commerce will release its calculation of first-quarter gross domestic product growth, which is arguably the most important indicator on the health of the country’s economy. For the first quarter of this year, the average analyst expectation for economic expansion stands at a 1.5 percent annual rate — a clear nod to the dramatic impact the extremely cold winter had on the United States economy. Frigid temperatures caused U.S. manufacturing output to record its biggest decrease in more than four-and-a-half years in January; kept job creation weak in December and January; contributed to a slowdown in consumer spending; and hurt residential construction, with January housing starts dropping to the lowest levels experienced in almost three years.
Since the recession ended nearly five years ago, GDP very rarely achieved what economists call ideal growth. Looking back to the first quarter of 2009, when GDP decreased 6.4 percent, recent data show the extent to which the economy has rebounded even, if the recovery has both failed to gain consistent momentum and remained slow by historical standards. On average, the U.S. economy has grown at an annual rate of 3.3 percent since 1929.
Generally, economists say a healthy rate of growth for GDP is between 2 percent and 4 percent. GDP growth fell within that range in the final three months of last year, expanding at a 2.6 percent annual rate. While that figure fell just short of economist expectations for an expansion of 2.7 percent, it still indicated that the U.S. economy had momentum heading into January’s harsh weather. It could be said that the fact that the economy grew only 1.9 percent over the course of 2013 mitigates the fourth quarter’s strength, but economists argue that the measure is misleading because it discards the year-over-year improvement.
Yet, with expectations for a weak first quarter, the fact remains that the country’s economy is climbing out of a huge hole. The nonpartisan Congressional Budget Office has quantified the damage: The agency now predicts that by 2017, GDP will be 7.3 percent, or $1.2 trillion, lower than estimates made in 2007. That projection, coupled with the volatility of recent GDP growth, has incited claims that the problem is structural stagnation. Brown University economists Gauti Eggertsson and Neil Mehrotra devoted a recent paper to the possibility that stagnation is the “new normal.”
“During the closing phase of the Great Depression in 1938, the President of the American Economic Association, Alvin Hansen, delivered a disturbing message in his Presidential Address to the Association,” reads the introduction. “He suggested that the Great Depression might just be the start of a new era of ongoing unemployment and economic stagnation without any natural force towards full employment.”
This idea was termed the “secular stagnation” hypothesis. Secular stagnation refers to persistently depressed economy. According to Hansen, one of the main driving forces of this new reality was a decline in the U.S. birth rate and an oversupply of savings that was suppressing consumer demand. World War II, which led to a massive increase in government spending, ended any concerns for insufficient demand, while the baby boom that followed drastically changed the demographic makeup of the United States, erasing the problem “of excess savings of an aging population.”
The authors say that Hansen’s thesis has resonance in today’s world. In the United States, weak economic growth and high unemployment have persisted despite the extraordinary measures implemented by the Federal Reserve. Even more importantly, insufficient understanding of what caused both problems has led to a lack of agreement among policymakers on how best to respond. Lawrence Summers, who served as the secretary of the Treasury in the Clinton administration, has postulated that the 2008 financial crisis ushered in the beginning of secular stagnation in the United States, just as Hansen suggested in 1938. Summers argued that an episode of low consumer demand may have even begun before 2008, but was masked by the housing bubble before the onset of the crisis.
Drawing on these facts, Eggertsson and Mehrotra theorized that the economy’s traditional self-correcting forces may be too weak to overcome the “very persistent slump.” As evidence, they cited the oversupply of savings associated with a permanent deleveraging shock, slower population growth, and an increase in inequality. Taken together, these factors deliver secular stagnation. The economic model Eggertsson and Mehrotra constructed demonstrates why this “long slump is one in which unusual economic rules are stood on their heads.” Still, the two economists do not provide a definitive explanation to the reasons for the country’s current slow economic growth.
However, Eggertsson and Mehrotra do note that one of the main takeaways from their analysis is not just that a permanent recession is possible, but that a liquidity trap can last as long as the particular dynamics that gave rise to it — including deleveraging shock, a rise in inequity, and a slowdown in population growth. In Keynesian economics, a liquidity trap describes a situation in which the injections of cash pushed into the private banking system by the central bank fail to lower interest rates, making monetary policy ineffective. Such a situation is caused when people hoard cash, rather than spend, because they expect an adverse event like deflation, insufficient aggregate demand, or war. The two economists conclude that this evidence “would suggest that a passive attitude to a recession of this kind is inappropriate.”
While it has been nearly five years since the U.S. economy began expanding after the 17-month recession, in many ways, this recovery is unique and lopsided. The stock market rally of 2013 was record-breaking: home prices in many regions of the country are returning to pre-recession levels, and corporate profits hit new highs last year, accounting for 11.1 percent of the nation’s economic output. But those improvements do not help wide swatches of the American population. Plus, many companies are not putting that cash back into the economy by hiring new workers. With hiring trending below pre-recession levels, leaving unemployment and underemployment exceedingly high and labor force participation near record lows, workers have little leverage to push for higher wages.
Poor employment gains spell larger problems for the U.S. economy. The relationship between business spending, job creation, and consumer spending, which accounts for approximately 70 percent of gross domestic product, is a close one. U.S. businesses do not want to increase labor costs unless their consumers spend money on the goods and services they produce. But consumers who are worried about their job prospects are not likely to spend beyond everyday necessities. Even though March retail sales rose by the largest percentage since September 2012 and government data suggest Americans are spending marginally more than in the past few months, the increases are still small on a historical level.
However, marginal improvements are expected for 2014. The Federal Reserve predicted that the economy will expand at between a 2.8 percent and a 3 percent rate this year, with the unemployment rate falling to between 6.1 percent and 6.3 percent. Already this year, despite weaker-than-expected job creation numbers in January, the jobless rate has ticked to to 6.7 percent. At last month’s meeting of the Federal Open Market Committee, policymakers continued to unwind the central bank’s extraordinary economic stimulus program. And while the fate of joblessness has fallen extremely close to the Fed’s targeted rate of 6.5 percent, Chair Janet Yellen thinks the economy is still far too weak to increase the federal funds rate.
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