November 14, 2012
The U.S. economy has grown slowly since the deep recession in 2008 and 2009, which was triggered by a sharp drop in house prices and a subsequent financial crisis. During the three years following the recession (that is, the third quarter of 2009 through the second quarter of 2012), the economy’s output grew at less than half the rate exhibited, on average, during other recoveries in the United States since the end of World War II. All told, between the end of the recession and the second quarter of 2012, the cumulative rate of growth of real (inflation-adjusted) gross domestic product (GDP) was nearly 9 percentage points below the average for previous recoveries. Researchers continue to grapple with understanding the roles that steep declines in house prices and financial crises play in slowing the growth of output.
In the current recovery, both potential GDP, a measure of the underlying productive capacity of the economy, and the ratio of real GDP to potential GDP have grown unusually slowly. Because potential GDP is an estimate of the amount of real GDP that corresponds to a high rate of use of labor and capital resources, it is not typically affected very much by the up-and-down cycles of the economy; in contrast, because the ratio of real GDP to potential GDP depends on the degree of the economy’s use of resources, it captures cyclical variations in real GDP around its potential level. In the first 12 quarters after the last recession, both potential GDP and the ratio of real GDP to potential GDP grew at less than half the rate that occurred, on average, in the aftermath of other recessions since World War II. Disaggregating the unusually slow growth in output since the end of the last recession, CBO’s analysis shows that that pace is mostly owing to slow growth in the underlying productive capacity of the economy and to a lesser extent, to slow growth in real output relative to that productive capacity.
Specifically, CBO estimates that about two-thirds of the difference between the growth in real GDP in the current recovery and the average for other recoveries can be attributed to sluggish growth in potential GDP. That sluggish growth reflects weaker performance than occurred on average following other recessions by all three of the major determinants of potential GDP: potential employment (the number of employed workers, adjusted for variations over the business cycle); potential total -factor productivity (average real output per unit of combined labor and capital services, adjusted for variations over the business cycle); and the productive services available from the capital stock in the economy. Although some of the sluggishness of potential GDP since the end of the last recession can be traced to unusual factors in the current business cycle, much of it is the result of long-term trends unrelated to the cycle, including the nation’s changing demographics.
The remaining one-third of the unusual slowness in the growth of real GDP can be explained by the slow pace of growth in the ratio of real GDP to potential GDP—which in CBO’s assessment, is attributable to a shortfall in the overall demand for goods and services in the economy. To identify the causes of that shortfall in demand, CBO analyzed the contribution of each main component of demand. Compared with past recoveries, this recovery has seen especially slow growth in four of those components:
- Purchases of goods and services by state and local governments,
- Purchases of goods and services by the federal -government,
- Residential investment (consisting primarily of the construction of new homes, home improvements, and brokers’ commissions), and
- Consumer spending.
Among those four components, purchases by state and local governments account for the largest portion of the unusual weakness. In contrast, two other components of demand—namely, investment by businesses and net exports—grew faster relative to potential GDP in the first 12 quarters of the current recovery than was the case, on average, in past recoveries.
A key underlying reason why the overall demand for goods and services by governments, businesses, and households has increased more slowly than usual in this recovery—and thus why real GDP has increased more slowly relative to potential GDP—has been the limitations faced by the Federal Reserve in providing support to the economy. Most important, because the interest rate that the Federal Reserve generally uses to conduct monetary policy (the federal funds rate) was already low at the start of the recovery, the central bank could not lower it much further even as the gap between real GDP and potential GDP failed to close quickly. Moreover, the economy has been less responsive than usual to low interest rates because of the oversupply of homes, the desire of households to reduce their indebtedness, and credit restraints imposed by lenders, among other reasons.
Much of the distress and dislocation associated with the recession and slow recovery stems from the shortfall of real GDP relative to potential GDP. In particular, during the recession and the early part of the recovery, the unemployment rate increased by 5 percentage points as real GDP fell relative to potential GDP, while during the rest of the recovery, the unemployment rate has declined somewhat as real GDP has stabilized (and slightly edged up) relative to potential GDP. In CBO’s judgment, the portion of slow growth in real GDP stemming from slow growth in potential GDP did not substantially affect unemployment.
Therefore, the bulk of CBO’s examination in this report focuses on the cyclical factors that help account for the sluggishness of the growth in real GDP relative to potential GDP, such as weak revenues for state and local governments and overbuilding during the housing boom.
corrected december 3, 2012
Dates on the x-axis for figure 6 were corrected on Dec. 3, 2012.