• The same factors that make a double-dip recession unlikely also argue against anything close to a recovery in proportion to the deep 2008-2009 recession. Sharp corrective adjustments during the recession form a base for sustained growth, but further correction in the sectors at the center of earlier excesses will retard the overall recovery.
• Where 31⁄4% real GDP growth was the norm during the credit bubble years, we now set our sites on 21⁄2%. Demand is restrained by de-leveraging, but the supply-side is also impaired, such that potential GDP growth may be less than 2% through 2011. In this case, growth of 21⁄2% would be sufficient to cap the unemployment rate at less than 10% in the near-term and to trim it to less than 9% by the end of next year.
A better-than-expected August employment report capped a week in which the U.S. data flow generally surprised to the upside, dispelling fears the economy might be losing momentum en route to a “double dip” recession. This scenario never seemed likely to us in light of the severity of corrective adjustments that have taken place since house prices peaked four years ago. Yet these same factors indicate that growth is going to be subdued – in the context of the 2008-2009 recession and in comparison to the two previous expansions.
Despite lean headcounts, an impaired labor market recovery. Unprecedented productivity growth during the depth of recession, and a brisk further advance in the early stages of recovery, indicated that businesses had likely reduced headcount below sustainable levels once demand re-normalized. As productivity growth inevitably moderated, re-hiring would commence, from levels low enough to argue against another round of cuts. Yet this general argument does not apply universally. More than a third of nonfarm payroll employment is in industries that are still retrenching (construction, financial activities, state & local government) or are unlikely to show typical growth in an expansion restrained by household sector deleveraging (retailing, automotive manufacturing). The sluggishness of these secularly constrained sectors is diluting the impact of a more lively cyclical recovery in the rest of the economy (Figure 1, page 1).
Housing supply overhang delays and dilutes cyclical construction rebound. The low level of housing starts – stable for 18 months at roughly half the rate required over time to keep up with population growth – is the linchpin of our view that residential construction will not be a drag on real GDP growth going forward. Yet the cyclical recovery has been delayed, and will be restrained by an overhang of vacant units. Thus, where the typical rebound from a deep housing recession adds over a percentage point to GDP growth in the first year of economic recovery,
residential construction added just 0.1 points (annual rate) over the last four quarters, and is likely to add no more than 1⁄4 point through the end of next year.
Drag of household de-leveraging abates, but the correction is not over. We estimate that the stock of household debt at mid-year was 4.8% ($634 billion) below its 2008 Q2 peak, and stood at 111% of disposable income, 12.5 points below its 2007 Q3 peak. Substantial further correction will largely reflect mortgage-related activity: defaults of existing mortgages, lower loan-to-value ratios on new mortgages and a slower flow thereof, reflecting a lower ownership rate.
At the same time, a three-year, four percentage point rise in the personal saving rate has brought into proximity with historical norms. A slower rise from here will reduce the drag on spending relative to income. Similarly, although the stock of debt remains high, the burden on income of servicing that debt is falling rapidly toward the 11%-12% range that prevailed before the 2000s credit boom (Figure 2).
We’ve seen this movie before
The Japanese economy expanded at a 4.5% annual rate over the ten years through 1990, but managed just 2% growth during the six-year expansion that began in 2002 with the supporting convergence of iscal stimulus, quantitative easing in monetary policy, and a systematic program to address nonperforming loans debts. In the U.S., where 31⁄4% growth was the norm during the credit bubble years, we now set our sites on 21⁄2%.
On the demand side, reduced growth expectations reflect the downshift in spending relative to income after the pre-crash overshoot. On the supply side they reflect the injuries that the economy has suffered in the asset price bubble and bust – the misallocation of labor and capital during the housing boom, the deferral of investment and R&D outlays during recession, the tardy redress of private and public sector institutional flaws – which undermine growth potential. The Congressional Budget Office pegs potential real GDP growth over the next 10 years at 2.4%, and at just 1.8% over the six quarters through the end of 2011.
Lower growth potential reduces the threshold for absorbing labor market slack. In Japan, the unemployment rate fell by 30% (from 5.4% to 3.8%) during the 2002-2007 expansion. Similarly, with U.S. growth potential restrained in the aftermath of a deep recession, growth of 21⁄2%-23⁄4%, in line with our forecast, would be sufficient to cap any further near-term rise in the unemployment rate at less than 10%, and to trim it to roughly than 9% by the end of next year. | |
