The Long Road Back

Five years ago, the economy appeared to be in freefall. Monetary policy and fiscal stimulus helped to halt the downslide, but a full economic recovery was still expected to take years. This wasn’t your father’s recession that we went through; it was your grandfather’s depression. We have made progress, but we still has very long way to go.

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The economy entered 2009 experiencing massive job loss. We were shedding nearly 800,000 jobs per month. It’s still frightening to think about. By the end of the year, job losses had ebbed. Job destruction has remained relatively low in the last few years, but hiring has been slow to pick up.

While some might joke that we simply ran out of people to fire in 2009, the truth is that monetary and fiscal policies played important roles. In a recession, automatic stabilizers kick in. Taxes fall. There is usually some recession-related increase in spending. The budget deficit rises (but is in no danger of crowding out private borrowing). President Obama pushed for an $800 billion stimulus package. The American Recovery and Reinvestment Act eventually cost $831 billion. John McCain, had he been elected, would have put forth a somewhat smaller-sized package. Some criticized the plan as wasteful; others criticized it as being too small given the magnitude of the economic contraction. A third of the stimulus was tax cuts, which did little to spur growth (a shift from spending to tax cuts was made to gain three Republican votes in the Senate). Spending was spread out mostly over just two years.

Rather than pump-priming, the ARRA can be thought of as simply plugging holes. It was large enough to stem the decline in economic activity, but not large enough to ensure a more rapid recovery. In hindsight, the ARRA reinforced what economists had generally believed – fiscal stimulus can have a rapid, positive effect on growth, but it is politically difficult.

The bank rescue and monetary policy also played important roles in halting the downturn. However, these efforts were never going to restore the economy’s strength overnight. Large firms were soon able to borrow from the big banks or go to the corporate bond market. For smaller firms, bank credit had tightened considerably in 2008. Five years later, credit is easier but still relatively tight. Small, newer firms typically account for a lot of the job growth during an expansion. Tight credit has limited the pace of recovery. However, it’s not simply an issue of the supply of credit. Many small firms with good credit don’t want to take on additional financial obligations until they see stronger demand for the goods or services that they produce.

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The slow economic recovery has taken a toll. The longer cyclical weakness goes on, the greater the chance it becomes structural weakness. The Congressional Budget Office estimates that potential GDP has slowed in recent years. The output gap has partly closed, but the gap would have been a lot larger if potential GDP growth has remained at its previous trend. For the long-term unemployed, the stigma of being without work for a long time and the deterioration of work skills makes it ever more difficult to find a job. Many teenagers and young adults aren’t acquiring the skills that they would normally, which tends to have a long-term impact on their lifetime earnings.

In recent weeks, the economic data reports have reflected weather-related softness. More importantly, many of these reports (retail sales, industrial production, factory orders, real GDP) also showed significant downward revisions to figures for November and December. Hence, there appears to have been less positive momentum at the end of the year.

Poor weather was also an issue in February, but not as much as in January. Still, it may be another month or two before we get a good, clear picture of the economy. As noted previously, the March to June period will be critical to this year’s outlook.

© Raymond James

© Raymond James

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