Piggybacking on my colleague Josh Bivens’ recent post refuting claims that the economy is “holding up surprisingly well,” it seems some in the press corps could benefit from a primer on economic expansion versus economic recovery. Rebounds in certain economic indicators, particularly stock indices and housing prices—very incomplete metrics of overall health being buoyed by the Federal Reserve’s quantitative easing asset purchases—are too often being conflated with or contributing to a “recovery” that presupposes the economy is recovering.
Part of this confusion likely reflects misidentification of the affliction at hand. The U.S. faces a sharp aggregate demand shortfall stemming from the housing bubble’s implosion and a jobs crisis that resulted from this pullback in spending by households, businesses and government. On these fronts, the U.S. is mostly oscillating between recovery and backwards progress, and “treading water” tends to be a better characterization than recovery since the end of 2010, after the Recovery Act’s boost faded and the federal government joined state and local governments on the austerity bandwagon.
And some of the confusion surely stems from putting stock in the wrong economic indicators. Unlike the S&P 500, the unemployment rate is often a solid metric of how the economy is working for the vast majority, but is currently quite misleading. The decline in the national unemployment rate mostly reflects distress in the labor market, not improvement; the national unemployment rate would register 9.7 percent in May (as opposed to 7.5 percent) if workers who have dropped out of the labor force for cyclical reasons were counted as unemployed.
The National Bureau of Economic Research, which tracks changes in U.S. business cycles based on a slew of economic indicators, has dated the Great Recession as lasting from December 2007 to June 2009, and the U.S. economy has subsequently been expanding since mid-2009. Economic expansion is a necessary but insufficient condition for economic recovery, particularly in the aftermath of such a severe shock to the economy as the housing bubble’s implosion.
Yesterday, the Bureau of Economic Analysis downwardly revised their estimate of annualized real GDP growth for the first quarter of 2013 to 2.4 percent. Some pundits are reading too much into stronger growth in the first quarter relative to the 0.4 percent annualized growth in the fourth quarter of 2012; as Josh points out, there’s a lot of noise in these annualized quarterly readings, particularly from swings in inventories and (lately) defense spending.
Looking at year-over-year real GDP growth paints a better picture of trend performance, and the U.S. economy has grown only 1.8 percent on an inflation-adjusted basis in the year to the first quarter. But problematically, this pace of economic expansion is inadequate in making progress towards economic recovery. The figure below charts year-over-year real GDP growth against the backdrop of the Congressional Budget Office’s projections of average annual growth in real potential GDP—essentially the rise in noninflationary potential output based on projected productivity and labor force growth.
Over 2013-2023, CBO estimates the economy’s full employment potential will grow 2.2 percent annually on average. But the economy’s actual economic output is currently depressed $958 billion (5.6 percent) below potential output as of the first quarter of 2013. (CBO’s estimates of potential output can be found here.)
To close this “output gap,” real GDP growth must exceed growth in potential real GDP growth, or the economy will at best be treading water or slipping further away from recovery. But since the economic boost from the Recovery Act peaked mid-2010, that’s been the exception, not the norm: year-over-year real GDP growth has topped 2.2 percent in only 2 of 9 quarters since the beginning of 2011, when the federal government pivoted from stimulus to austerity at the start of the 112th Congress. In relative terms, the output gap peaked at 7.5 percent of potential GDP in the third quarter of 2009, as the Recovery Act arrested economic contraction, but has only subsequently shrunk to 5.6 percent—suggesting the economy is roughly one-fourth of the way to full economic recovery.
CBO’s economic forecast shows year-over-year real GDP growth slowing to 1.4 percent by the fourth quarter of 2013, with the output gap re-expanding to 6.0 percent of potential—where the economy was at in fourth quarter of 2010. This is what economic expansion without recovery looks like. The U.S. economy mired in an adverse equilibrium of anemic growth, severely depressed output, massive underemployment, large cyclical budget deficits, subdued price inflation, widespread real wage deflation and low interest rates—and it’s a frighteningly sustainable cycle (see Japan).
The U.S. labor market tells a parallel story of sustained job growth as necessary but insufficient for relative improvement. As a rule of thumb, just over 100,000 jobs are needed every month just to keep up with population growth, so it’s employment growth in excess of this benchmark that exerts trend downward pressure on the unemployment rate; employment is 2.6 million jobs below precession levels, but another 6.1 million jobs are needed to keep up with labor force growth since the start of the Great Recession, as depicted by the “jobs gap.” As my colleague Heidi Shierholz points out, slogging on at the trend pace of 175,000 jobs added per month since late 2010 wouldn’t close this gap until 2020. This State of Working America figure depicts the employment to population ratio for “prime-age” (25-54) workers in the aftermath of the recession, Heidi’s preferred measure of the relative improvement in the labor market to date (and how far we are from full economic health). Similar to the output gap, a little under one-quarter of the difference has been made up between pre-recession health and the downturn’s trough.
As a rule of thumb, you need real GDP growth between 2.0 percent and 2.5 percent to make sustained improvements in the labor market. Pundits and politicians should not be complacent about trend economic expansion in or below this range—there’s still way too much ground to be made up in the aftermath of the Great Recession, and the opportunity cost of remaining stuck in our current adverse economic equilibrium is staggeringly high. At full employment, real GDP growth in line with potential GDP growth isn’t cause for concern, but it is unacceptable when it is keeping the economy depressed nearly $1 trillion below full employment levels.
For a more thorough analysis of the state of the U.S. “economic recovery” and what would be needed to restore full employment, see From free-fall to stagnation: Five years after the start of the Great Recession, extraordinary policy measures are still needed, but are not forthcoming, coauthored with Josh and Heidi.