Chapter I: The United States Economy

Overview

The United States opened 2020 with a strong economy with unemployment at near-historic lows and was in the midst of the longest period of economic expansion in its history. In March of 2020, the US experienced its most abrupt and severe economic shock in history due to the COVID-19 pandemic. Economic output fell by more than 30 percent on an annualized basis, around 25 million jobs were lost, and the unemployment rate soared from under 4 percent up to around 15 percent. All of this occurred within roughly a two-month period. The US has already shown significant signs of economic improvement, adding back, for example, around 10 million of the jobs that were lost and observing an unemployment rate that has already fallen below 10 percent.

We expect a relatively quickly recovery from the deep recession that emerged in 2020. For example, as discussed below, we expect a full employment recovery by early-2023. However, it must be clearly stated that economic forecasting is extremely difficult at this time given the unprecedented nature of this recession coupled with the fact that the recovery largely depends on public health matters, rather than economic matters. As such, in the economic forecasts presented below, we present the baseline as well as alternative scenarios that rest on more optimistic or pessimistic assumptions. ^{^[1]} In this chapter we: a) explore recent trends in the United States economy; b) provide a forecast of how the US economy is likely to evolve over the coming five years; and c) explore several major challenges that have the potential to threaten the long-run US economic outlook.

Recent Trends and Intermediate-Term Economic Outlook

GDP As illustrated in Figure 1.1, economic output, as measured by real Gross Domestic Product (GDP), fell dramatically in early 2020 due to the COVID-19 pandemic, after several years of relatively stable growth around two percent. This drop came after what had been the longest economic expansion in the nation’s history. The drop in GDP was very rare in terms of its speed and unexpected nature. Overall, the 2 ^nd quarter drop in economic output was nearly 10 percent on a year-over-year basis (shown in figure). Measured differently, the drop was in excess of 30 percent on an annualized basis. Later in this chapter we return to a broad discussion of how GDP will likely look as the nation recovers from this pandemic.

United States Real GDP Growth Chart showing that U.S. real GDP growth has average about 2% since the Great Recession, with a large negative growth in early 2020.

[Figure 1.1]

PRODUCTIVITY Worker productivity, as measured by output per hour worked, is the fundamental key driver of economic prosperity over the long run. For instance, very high levels of productivity fundamentally explain why nations such as the US and UK enjoy high standards of living while very low levels of productivity explain why nations such as Haiti and Zimbabwe suffer extremely low standards of living. In Figure 1.2 we illustrate the intermediate-run growth in productivity in the US over the last two decades or so. As illustrated, productivity growth has been has been low by historic standards since 2013. Productivity growth is expected to remain below the 30-year average, and the question of why this is the case continues to be hotly debated among economists and policymakers.

Growth in Output per Hour in Nonfarm Business Chart showing how U.S. productivity, measured in growth per hour in nonfarm businesses, has trended upward since 2013, but it still remains below the 30-year average

[Figure 1.2]

GOVERNMENT SPENDING The recent evolution of government spending in the US is reported in Figure 1.3. Total federal, state, and local government spending, which amounts to approximately one-third of US GDP, increased substantially during the Great Recession. This rise was driven by a concerted economic stimulus effort that actively increased government spending and as safety net expenditures rose naturally as the economy went into recession. After the economic recovery began, inflation-adjusted federal government spending decelerated rapidly and started to declined outright for four years. This decline was driven by the waning of federal government transfer policies as well as federal sequestration policies. In contrast, real federal government spending did pick up in recent years, and will be much higher for 2020. This increase was driven by several discretionary spending choices made by Congress over the past couple of years or so and very aggressive stimulus measures for 2020.

Growth in United States Government Spending Chart showing that real U.S. government spending fell following highs during the Great Recession, but it has since increased in recent years.

[Figure 1.3]

EMPLOYMENT As depicted in Figure 1.4, total US employment from the household survey was extremely strong at the beginning of 2020 – slightly above what economists consider to be the maximum level of employment that the economy can sustain for the long run. Then the economy dramatically lost around 25 million jobs over a roughly two-month span due to the COVID-19 pandemic. As of the most recent data, the nation has gained back around 10 million of the lost jobs. We return to a discussion of the employment forecast below.

United States Total Employment Chart showing actual employment and full employment levels for the past two decades.

[Figure 1.4]

UNEMPLOYMENT Turning to the unemployment situation, the national unemployment rate peaked at around 10 percent in late-2009, as noted in Figure 1.5. This was the second-highest jobless rate experienced during the post-WWII era, exceeded only by the 1982/1983 recession (a peak of 10.8 percent in late-1982). The unemployment rate improved very steadily through the beginning of 2020, reaching a near historic low of below four percent. In sharp contrast, the rate skyrocketed over a two-month period in early-2020 due to the COVID-19 pandemic, reaching a high of nearly 15 percent, the highest rate observed since the Great Depression in the 1930s. The figure fell sharply in mid-2020 as the pandemic lockdowns eased, and now stands below 10 percent.

United States Unemployment Statistics Chart showing the U.S. unemployment rate has steadily decline since the Great Recession, with a sharp increase in 2020, and percent of people unemployed for 27 weeks or more has followed a similar trend, except it dec

[Figure 1.5]

Another important statistic is the share of all unemployed persons who have endured long unemployment spells, which is typically defined as 27 weeks or more. As illustrated, this figure rose substantially during the last recession, did finally return to long-run norms by 2018, in conjunction with improvement in the unemployment rate over that period. The figure plummeted in early-2020 as millions of newly unemployed men and women joined the unemployment rolls.

There are two common criticisms associated with the conventional unemployment rate reported in Figure 1.5. The first is that the figure does not account for workers who can only find part-time work but who would prefer a full-time opportunity, often referred to as “under-employed.” The second relates to discouraged workers. Here, the idea is that if one is looking for work for an extended period of time and is ultimately unsuccessful at landing a job, the individual may become discouraged and quit looking for work altogether. When this happens, the person is no longer counted as “unemployed” or part of the labor force at all by the conventional measure, since the conventional measure only considers people we are actively looking for work. For both of these reasons, the conventional unemployment rate understates the overall severity of the unemployment situation.

In Figure 1.6 we report the conventional unemployment rate (referred to as U-3) along with a measure that also includes discouraged workers and individuals who are only able to find part-time work due to economic reasons (U-6). It is important to note that these criticisms are legitimate and that what many would consider to be “true” unemployment is higher than the conventional statistic indicates. However, it is also important to note that the movement of the two figures over time is quite consistent and despite their level differences, the unemployment situation has improved demonstrably in recent years until the COVID-19 pandemic, regardless of which metric is used.

United States Unemployment Statistics Chart comparing the trends of the conventional unemployment rate, permanent job losers, and an unemployment rate that includes discouraged workers.

[Figure 1.6]

LABOR FORCE PARTICIPATION The labor force participation rate is a complementary measure to the unemployment rate. The labor force participation rate captures the share of the adult population that would like to work—termed “in the labor force”—while the unemployment rate captures the share of the labor force that is unable to find employment at any given moment in time. Ultimately, the labor force participation rate is a more fundamental descriptor of an economy’s long-run employment situation.

In Figure 1.7 we report labor force participation for the US since 1950. As illustrated, the figure peaked in the late-1990s at 67 percent, fell substantially after 2008, improved slightly over the past couple of years, standing at just over 63 percent in early-2020. The broad evolution of this figure is largely driven by demographic processes, namely the emergence and aging of “Baby Boom” generation. Notice that the figure began to rise substantially around 1965, when the first of the “Baby Boomers” turned 20 years old. This measure continued to rise through around 1998, when the first of this group turned 55 years old, but then began to decline substantially around 2008—the point when the leading edge of the Baby Boom approached conventional retirement age. The figure fell substantially once again during 2020 as some of the men and women who lost their jobs due to the pandemic left the labor force altogether.

In addition to the baby-boomer effect, the post-WWII structural change in labor force participation rates was driven in large part by large increases in the female labor force that occurred through the mid-1990s. Overall, the recent declines in labor force participation likely present an impediment to the nation’s long-run economic growth potential as fewer workers will be available to support retirees vis-à-vis private pension plans as well as Social Security and other federal programs. Furthermore, many economic challenges below might interact with a lower rate of labor force participation in the long run, leading to a significantly different performance for the US economy over the long term.

United States Labor Force Participation Rate Chart showing the U.S. labor force participation rate has fallen since the Great Recession, recovered about two percent in recent years, but sharply decreased in early 2020.

[Figure 1.7]

UNEMPLOYMENT INSURANCE CLAIMS Following up on our discussion of unemployment, in Figure 1.8 we report the number of initial unemployment insurance each week nationally. As illustrated, the figure was very stable at around 230 thousand leading into the COIVD-19 pandemic. The figure skyrocketed to nearly six million in an extremely short period of time through March and April of 2020. After dramatic improvement as well in late-May and June, we have observed slower improvement, and the figure remains well above the pre-COVID-19 norm.

Weekly Initial Claims of Unemployment Insurance Benefits Chart showing that the 4-week moving average of weekly initial unemployment insurance claims was steady at around 230 thousand before the pandemic, but it increased to nearly 6 million in March an

[Figure 1.8]

CONSUMER CONFIDENCE Recessions typically have a catalyst in some exogenous shock (such as the bursting of a housing bubble or high oil prices), but falling consumer sentiment is often the key driver of demand during recessions. Typically, the initial recession catalyst reduces demand directly, and thereby output. This drop in output reduces confidence, which reduces demand further, and a vicious cycle ensues. On the upswing of the business cycle, an economic system is unlikely to ever achieve its full potential until confidence is restored.

As reported in Figure 1.9, US consumer confidence fell markedly in early-2020 in response to the COVID-19 pandemic and has shown little sign of improvement since. Improving confidence will be key to a full economic recovery.

Consumer Confidence Chart showing that consumer confidence has steadily improved since the Great Recession, with a sharp decline in early 2020.

[Figure 1.9]

Economic Outlook

GDP OUTLOOK As described above, economic forecasting is especially difficult currently given the nature of the current recession and the fact that much of the recovery depends on public health matters, rather than economic matters. As such, we present a baseline forecast, but we include additional bounds on our forecasting reflecting more optimistic or more pessimistic assumptions.

As illustrated in Figure 1.10, our baseline forecast calls for continued declines in GDP in 2020, followed by very strong growth in 2021. Further, we expect above-average growth for two more years as full recovery emerges, until the economy settles back into its normal growth pattern around 2024. The more optimistic scenario presents a similar pattern, but a faster path to full recovery. The pessimistic scenario foresees negative GDP growth continuing into 2021, and correspondingly, a longer time period to return to normal GDP growth patterns.

United States Real GDP Growth Chart comparing optimistic, baseline, and pessimistic forecasts for the recovery of U.S. real GDP growth over the next five years.

[Figure 1.10]

EMPLOYMENT and UNEMPLOYMENT OUTLOOK Our employment outlook is illustrated in Figure 1.11. The baseline forecast calls for employment to recover around half of the jobs lost due to the COVID-19 pandemic by the end of 2020. Full recovery is not expected until early-2023. The pessimistic forecast does not call for full recovery until 2024. In Figure 1.12 we present the forecast for the unemployment rate. The baseline forecast calls for a rate of around eight percent by the end of 2020. Further, the baseline expectation is for the rate to remain above the normal range of around five percent for nearly two additional years. The figure also illustrates the more optimistic and the more pessimistic forecasts. All three scenarios place the unemployment at full recovery by 2024.

United States Total Employment Chart comparing optimistic, baseline, and pessimistic forecasts for the recovery of U.S. total employment over the next five years.

[Figure 1.11]

United States Unemployment Rate Chart comparing optimistic, baseline, and pessimistic forecasts for the recovery of the U.S. unemployment rate over the next five years.

[Figure 1.12]

Challenges Facing the US Economy

Issues related to the long-run sustainability of the US federal government budget remain a primary concern for long-run economic growth. As such, we explore US federal government budgetary issues through figures 1.13 through 1.15.

FEDERAL GOVERNMENT DEBT As depicted in Figure 1.13, federal debt held by the public, which was consistently below 40 percent of GDP between 2000 and 2008, began rising dramatically in 2008 as tax revenues plunged and the federal government ramped up spending in part to stimulate the weakening economy. This shock placed the figure is in the upper-70-percent range, a rate that is nearly double the average from the prior 30 years. Further, fiscal policy actions in 2019 and aggressive stimulus measures so far in 2020 have increased the figure once again, now to a level just above 100 percent of GDP. This places the figure at its highest level since the World War II Era. The figure is expected to rise further in 2021 due to ongoing effects of the COVID-19 pandemic. Further, assuming no changes in public policy, the figure is forecast to explode in the long run (not shown) given the aging of the US population and the additional public benefits that an older population receives (i.e. Medicare and Social Security).

A public debt level that surpasses a critical level can be detrimental to long-run economic prosperity if the public debt becomes large enough to drive interest rates high enough that they ultimately crowd out private-sector savings and investment activity—a key driver of productivity growth in the long-run. While economists are unsure of what that critical level is, clearly the US is much closer to that level compared to historical norms that existed before the 2008 recession.

US Federal Debt Held by the Public as a Share of GDP Chart showing that U.S. federal debt as a share of GDP went from around 30% to 70% following the Great Recession, with events in 2019 and 2020 sharply increasing it further.

[Figure 1.13]

TRANSFER PAYMENTS The recent dynamic involving US federal government debt is closely related to the increase in transfer payments from the US federal government. Examples of transfer payments include Social Security, unemployment benefits, welfare benefits, Medicare, and Medicaid. As illustrated in Figure 1.14, transfer payments increased substantially in 2008, reaching a high of around 18.5 percent of personal income, compared to a 30-year average of around 15 percent. Recent stimulus efforts have dramatically increased the figure further, placing it in excess of 23 percent for 2020, and it is expected to remain at that level for 2021. Both waves of increase are attributable to two major factors: a) falling income and rising unemployment during recessions, and b) more generous public policy, such as the extension of unemployment benefits. The figure is expected to fall to around 22 percent by 2022, but this still places the figure well above historic norms.

Figure 1.14: US Transfer Payments as a Share of Personal Income Chart showing that U.S. transfer payments as a share of personal income increased above historic norms following the Great Recession, with a further increase in 2020 due to the pandemic.

[Figure 1.14]

In Figure 1.15 we report the composition of US federal government spending. As illustrated, mandatory spending, which includes transfer payment programs such as Social Security, Medicare, Medicaid, unemployment insurance, and the like, comprised 67 percent of all federal spending in 2019. This represents an important increase over the past 20 years or so and comes largely as a result of an aging population. At the same time, defense spending and nondefense discretionary spending have fallen correspondingly. If the long-term debt burden is to be reduced, it will have to be accomplished through either higher taxes, or a reduction in one of these areas of spending, and each path carries its own set of concerns and difficult political realities.

Components of US Federal Government Spending Pie chart showing that mandatory spending made up 67% of U.S. federal government spending in 2019, defense spending was 17%, and nondefense discretionary spending was 16%.

[Figure 1.15]

INFLATION As reported in Figure 1.16, inflation has been mostly modest by historic standards in the US for more than two decades, rarely moving outside of the 1 to 3 percent range. Inflation has been below its long-run average with only one exception since the Great Recession ended. Core inflation, which excludes food and energy prices from the equation (yellow line in figure), has been below the 2 percent figure that monetary policymakers explicitly state as a target since the beginning of 2012. The figure is expected to remain modest or on target throughout the forecast.

United States Inflation Rates Chart showing the U.S. inflation rate has remained below the Federal Reserve’s targeted inflation rate of two percent for most of the last decade, and it is forecasted to remain that way for the next five years.

[Figure 1.16]

However, there is a chance that faster growth in price levels could eventually re-emerge. The US Federal Reserve (Fed) took unprecedented steps to stabilize the economy during the Great Recession and in 2020, and in so doing has increased the monetary base—primarily the volume of reserves held by banks—dramatically through its purchase of US Treasury Securities and other assets, such as private-sector mortgage-backed-securities. This monetary stimulus has not translated into higher inflation due to continued modest demand and banks’ reluctance to lend and other factors. But inflationary pressures will eventually have the potential to build as lending and the broader economy improve. As such, the Fed will eventually have to withdraw liquidity from the monetary system so as not to create an environment for inflation to build. The uncertainty stems from the fact that monetary policy across the globe is in uncharted territory given the volume of monetary stimuli over the past decade, and particularly in 2020, the nature of the asset purchases, and the persistence of negative interest rates in major economies such as the European Union and Japan and other areas.

INTEREST RATES A related concern is interest rates in the US economy in the very long run. We have observed the Fed’s “normalization” process in recent years wherein the Federal Open Market Committee (FOMC) unwound some of its previous asset purchase programs and other forms of monetary stimulus discussed above during the Great Recession. Short-term interest rates generally climbed in concert with hikes in the federal funds rate by the Fed over recent years. IN response to the COVID-19 pandemic, the Fed reversed course earlier this year and aggressively again lowered interest rates again in order to provide new stimulus to the economy. Although rates are expected to remain very low for several years, eventually rates will rise again and if rates rise too quickly, it could precipitate much weaker levels of investment and consumer spending growth. On the other hand, if the Fed waits until too late to allow rates to rise, inflation would eventually be a concern. Figure 1.17 reports the forecast for three key US interest rates.

Figure 1.17: Select United States Interest Rates Chart showing the 30-year mortgage rate, 10-year Treasury rate, and the federal funds rate.

[Figure 1.17]

INCOME INEQUALITY The final concern that we consider relates to rising income inequality in the US. In Figure 1.18 we illustrate the share of aggregate income in the US that is earned by households divided into quintiles. As illustrated, the lowest-income quintile, while representing 20 percent of households, earned around 3 percent of the total income in the nation in 2018. The second lowest-income fifth of households earned around 8 of the total income in the nation in 2018, and so on. The highest-income quintile earned nearly 52 percent of the nation’s total income in 2018. Further, as illustrated, the income share for the highest quintile has risen by nearly 9 percentage points over the period illustrated, corresponding to a decline in the share earned by the other quintiles. In a similar vein, in figure 1.19 we report median income in the US over the long-run, compared with the average income for households in the highest-earning five percent (after accounting for inflation).

Overall, many individuals are concerned about the growing income concentration among higher income households and these individuals have often requested or proposed public policies that could reverse this trend. Finding an appropriate public policy response that balances promoting economic growth overall and achieving a socially-acceptable income distribution can prove to be challenging in many cases. However, it is clear that education plays an important factor in explaining the income distribution in the U.S. As reported in Figure 1.20, households where at least one resident holds a bachelor’s degree earn far more than any other group, and the gap between those with a bachelor’s degree and others has risen slightly over time.

Share of Aggregate Income by Quintile Chart showing that the income share of the highest quintile earners has risen in the past 50 years while the income share of each of the other four quintiles has fallen in the same period.

[Figure 1.18]

Income of the Top 5 Percent vs. Median Household Income Chart showing that real median household income has remained relatively flat at $50,000 since 1970, but the income of the top five percent has doubled from $200,000 to over $400,000.

[Figure 1.19]

: Median Income by Householder’s Educational Attainment Chart comparing the median income of different educational attainment levels, with householders who have a bachelor’s degree being 3-4 times higher than those with no high school degree.

[Figure 1.20]