It’s dangerous to express optimism about the economy these days. Europe’s financial markets remain fragile. China, which supports much of the world’s economy through imports, is too dependent on highly indebted, state-subsidized corporations. The Federal Reserve may reverse its low-interest-rate policy. Nevertheless, there is at last some fundamentally positive economic news to be reported: the United States may be on the verge of GDP growth rapid enough to bring down the unemployment rate substantially.
The nation’s debt as a percentage of GDP has stabilized and is forecast to begin falling in 2015, while consumer debt has already dropped significantly since the financial crisis set in. Research by the Harvard economists Kenneth Rogoff and Carmen Reinhart shows that recessions caused by financial bubbles take a longer time to recover from, as governments and consumers pay off debt rather than spending. This has certainly been true since the collapse of the housing bubble. But there is reason to believe that U.S. households and government have returned themselves to manageable levels of debt.
Following major spending cuts and modest tax increases, the federal deficit is now running at about 5 percent of GDP, compared with 10 percent in 2009. In 2013, the deficit will fall below the trillion-dollar mark, and the recent round of planned cuts and tax changes may already have put us back on a sustainable path. Meanwhile, health-care costs — the principal factor in projected increases in Medicare and Medicaid spending over the next decade, and especially beyond — have for four years been rising more slowly than expected, prompting the “nonpartisan” Congressional Budget Office to knock several hundred billion dollars off its federal-deficit projections for 2020. This is considerably more than reforms proposed by President Obama or Congress would achieve. In the long run, the beneficial consequences of slow growth in health-care costs could be far greater. The CBO now figures that the nation’s debt will for the foreseeable future remain slightly above 70 percent of GDP, which most economists believe to be an acceptable level.
Some influential Republicans are now noticeably more subdued on the deficit front than they were during last year’s presidential election or during the 2011 debt-ceiling debacle. In late January, a top Republican adviser and former aide to House majority leader Eric Cantor wrote on Twitter that “conservatives would be wise to focus on economic growth and job creation instead of austerity/cuts alone.” A few weeks later, Cantor made a speech at the conservative American Enterprise Institute in which he attempted to divert attention away from budget issues and toward education and health care. After Congress and the president conclude another seemingly unavoidable fight this spring about raising the legal debt limit — a serious threat, because failure to do so could lead to defaults on Treasury debt — the deficit wars may be just about over. That would mean much less of a headwind for the economy.
More important than any government news, however, is the fact that the U.S. consumer is once again financially pretty healthy. In the 2000s, Americans took on huge amounts of debt — mortgages to finance their new houses; home-equity loans to buy appliances, pay for college, and take vacations; credit card debt to cover everyday needs. Debt, not rising wages, is what kept the economy running through most of the Bush years. It masked a systemic weakness that most economists warned us about too late. Household debt service — the amount required in a given period to pay both interest and debt principal — reached more than 14 percent of after-tax income in 2007, just before the Great Recession was to get under way.
In the past couple of years, consumers have been paying off these debts. The Federal Reserve has kept interest rates low. Even as levels of some types of borrowing, such as college loans, remain high, overall debt service is down to about 10.5 percent of income, the lowest it’s been since 1981. As a result, consumers are likely to start spending again, businesses to start investing — the virtuous circle that drives economic growth.
A rebound in housing is a key component of full-fledged economic recovery. Though reductions in debt levels and interest payments don’t always mean that consumers will start buying big-ticket items like houses again, there is real evidence that just this is happening. Building permits are up strongly, while the inventory of unsold homes is down. (Foreclosed properties left fallow for several years are no longer salable — a sad fact, but one that reduces the inventory of houses available to be sold.) Purchases of furniture and appliances are also up. Construction companies’ stock prices have risen sharply, and these companies are hiring workers. And, most important, housing prices are up 6 percent since bottoming out last winter.
Meanwhile, pent-up demand should continue to drive sales: younger Americans who postponed home-buying plans through their twenties, often moving in with their parents, have been able to save up the down payments needed to make a purchase.
Some interpret Rogoff and Reinhart’s research to mean that a slow recovery from a debt bubble of the kind this country experienced is inevitable. But historically, failure to bounce back has been the result not of fate but of poor response. This time around, too, American policy was inadequate to the task. The $800 billion stimulus passed in early 2009 was extremely useful, but the Obama Administration, like its predecessor, failed to pursue aggressive mortgage relief, even though the Troubled Asset Relief Program provided the tools and money to do so. After establishing the Home Affordable Mortgage Program, the administration spent little of the $50 billion set aside for mortgage relief; only about 1 million mortgages were modified. Had more mortgage holders been made whole, the economic recovery would have gathered steam more quickly.
Another policy failure was the Federal Reserve’s continual focus on restraining inflation, an obsession it has had since the early 1980s. Most members of the Fed are focused instead on cutting the unemployment rate. As a result, even if inflation rises, Ben Bernanke and his colleagues are likely to keep interest rates low to promote job creation. The average rate on a thirty-year mortgage is around 3.5 percent, and it isn’t likely to rise significantly in the next two to three years. Despite early warnings from such right-wing scholars as Niall Ferguson of Harvard and John Cochrane of the University of Chicago, there is no inflation to be found; economists at Goldman Sachs, among many others, believe inflation is not likely to reach the 2.5 percent threshold the Fed has now set anytime soon.
For a reduction in unemployment, GDP must grow fast enough to generate jobs for both those out of work and those newly entering the workforce. The growth of between 2 and 2.5 percent that we’ve had in recent years is clearly inadequate to this task. But it finally looks possible to generate 3 or even 4 percent growth, as Jan Hatzius of Goldman Sachs and Mark Zandi of Moody’s Analytics are forecasting for the next couple of years. Josh Bivens of the Economic Policy Institute thinks it is plausible that a growth rate of 4.25 percent a year for several years in a row could get unemployment down close to 5 percent.
Even if these optimists are right, we should not count on the natural self-adjusting forces of the economy alone. In the short run, more fiscal stimulus will be needed. Ideally, increased federal spending would be directed to infrastructure. A recent study by the Federal Reserve Bank of San Francisco found that every dollar of federal highway grants a state receives increases that state’s gross product by two dollars. Another $100 billion in annual infrastructure spending — a doubling of current federal authorizations — would make good sense. For this reason, the misguided “austerians” in Washington may be the single biggest threat to the kind of recovery that could bring down unemployment. As the deficit falls, fortunately, there ought to be less resistance to such public investment by fiscal hawks.
The most important thing the federal government can do to generate jobs may well be to reduce the nation’s trade deficit. The United States imports about $500 billion more in goods and services each year than it exports. In February, the Economic Policy Institute released a study with another think tank that calculates that as much as four fifths of this deficit is caused by currency manipulation and government subsidies by major trading partners. Reducing these interventions, the study argues, could create roughly 2 to 5 million U.S. jobs, reducing unemployment by between 1 and 2.1 percent.
Given diplomatic sensitivities, it’s not likely the Obama Administration will take many of the steps the study suggests, such as refusing to sell U.S. bonds and other assets to trading partners unless they forgo manipulation. (Some countries have accused the Fed itself of manipulation, claiming its low-interest-rate policy is suppressing the U.S. dollar, making our exports more competitive.) But the administration doesn’t have to take so hard a stand; it could instead apply more pressure on these nations to raise wages and improve working conditions domestically. There are promising signs in this direction. Foxconn, the Chinese electronics-manufacturing giant, recently announced it would allow its workers to unionize.
Some among the antigovernment ideologues, deficit and inflation hawks, and trained economists who disparage government spending and investment insist that we will never have full employment because American workers don’t have the requisite skills. But the data shows that worker shortages are in most sectors not serious, and there have been no substantial increases in wages, which would be the usual result of such shortages.
Rapid growth, encouraged by both fiscal and monetary policy in Washington and coupled with significant public investment in infrastructure, targeted investment in certain industries, and some measure of trade pressure, can get America back to full employment. With demand rising, investment will also rise — and the commercial innovation that may have been lying dormant because of slow growth, to say nothing of the investments wasted on housing since 2000, could then flourish.
After some rough sledding in the first half of the year due to spending cuts and tax hikes coming out of Washington, we may now be seeing the beginning of something the U.S. economy hasn’t witnessed in a generation: substantial growth based more on jobs and wage increases than on consumer debt.
