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Chapter I: The United States Economy


The United States remains on a path to recovery after the onset of the COVID-19 pandemic caused the nation to experience its most abrupt and severe economic shock in history. After seeing massive collapses in economic output and employment during the second quarter of 2020, some topline measures such as real GDP, consumer spending and business investment have surpassed levels seen prior to the pandemic. Some aspects of the economy, such as payroll employment, still lag pre-pandemic levels, but the increased availability of vaccines and therapeutic treatments has enabled more than three-fourths of the jobs lost during the early pandemic response to be recovered.

Even with these improvements, however, the COVID-19 pandemic continues to exert its influence on the broader economy, especially as new cases and hospitalizations have surged to pandemic-level highs in some states due to the spread of the highly infectious Delta variant. In addition to the impacts associated with the Delta variant surge, the pandemic has thrown global supply chains into disarray for much of the past year and when combined with the release of pent-up consumer demand, price levels for some goods and commodities have risen rapidly over the course of 2021. Finally, labor markets remain encumbered by the pandemic to some extent as employers in some sectors have had to aggressively raise starting wage levels for jobs due to historic levels of unfilled job openings.

Overall, we expect the US economy to remain on a continued path of economic recovery going forward and for a return to pre-pandemic levels of employment by some time around mid-2022. However, the lingering presence of the pandemic remains a source of uncertainty, though its impact is expected to decline further as increased testing, availability of vaccines to younger children and more therapeutic treatments entering the market the burden of COVID-19 disease will be dramatically reduced. 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 outbreak of the COVID-19 global pandemic. While the drop was historic in terms of its speed and depth, real GDP has recovered at a very strong pace over the past several quarters. Indeed, after collapsing by more than 9 percent during the second quarter of 2020, real GDP has rebounded over the past four quarters to the point that it now sits at nearly 1 percent above its pre-pandemic level during the second quarter of 2021. Later in this chapter we return to a broad discussion of how GDP will likely look like as the nation recovers from this pandemic.

Figure 1.1 shows a line graph of real US Gross Domestic Product growth since the mid-2000s. After several years of relatively stable growth at two percent or so, real GDP dropped dramatically in Q2 of 2020 due to the COVID-19 pandemic but has registered s

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 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.

Figure 1-2 shows a chart of worker productivity, as measured by output per hour worked averaged over the past three years. Increases in worker productivity are considered to be a main driver of economic growth over the long term but even though it has tre

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, declined through the years 2011 through 2014, as the economy recovered from the Great Recession and removed associated stimulus measures. However, government spending again began to grow at a faster pace in 2018 and 2019, followed by rapid growth in 2020. Although not shown, federal spending will be very high for 2021 as well. This much higher rate of federal spending in 2020 and 2021 was the result of very aggressive stimulus measures passed in response to the recent recession.

Figure 1.3 contains a two-line graph of changes in state and local spending compared to federal spending. After decelerating in the early 2010s, total federal, state, and local government spending gradually increases. Federal spending has accelerated over

EMPLOYMENT As depicted in Figure 1.4, the US labor market was in very good shape prior to the pandemic, and in fact was growing at levels that exceed what economists generally perceive as the maximum level of jobs the economy can sustain over the long run (also referred to as “full employment”). Over the course of the initial onset of the COVID-19 pandemic, nearly 25 million people in the US lost their jobs. While the US labor market cannot be strictly defined as that of as a “V-shaped recovery,” the rebound in payrolls over the last year or so has been strong as the most recent reading shows nearly 20 million jobs have been recovered between April 2020 and August 2021. We return to a discussion of the employment forecast below.

Figure 1.4 consists of a two-line graph that plots total employment from the monthly household survey and compares it against the theoretical level of full employment. Employment fell dramatically by around 20 million during the second quarter of 2020 due

UNEMPLOYMENT Turning to the unemployment situation, the national unemployment rate stood at a low of 3.6 percent just before the beginning of the COIVD recession, as noted in Figure 1.5. This was one of the lowest jobless rates experienced since the beginning of modern economic statistics. The unemployment rate skyrocketed at an unprecedented pace, reaching a peak of nearly 15 percent in the Spring of 2020. However, the rate improved rapidly as COVID-based lockdowns ended in 2020 and has continued to improve in 2021. Currently the rate stands in the low-five percent range.

Figure 1.5 illustrates the overall unemployment rate compared to the share of unemployed who have been out of work for at least 27 weeks. The jobless rate was at or below 5 percent from late-2015 through early-2020 before skyrocketing to nearly 15 percent

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 was below 20 percent in early-2020. However, the figure has risen significantly over the first part of 2021, surpassing 40 percent. However, in recent months the figure has started to show signs of improvement, signaling a return to a healthier labor market.

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 who are actively looking for work. For both 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.

Figure 1.6 figure shows three alternative measures of the unemployment rate. The traditional measure, known as U-3, as well as the U-6 definition, which includes discouraged workers and those marginally attached or working part-time for economic reasons.

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, and then maintained stability up until the 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

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 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.

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.

The figure once again fell substantially immediately as a result of the COVID-19 recession, as “discouraged workers” left the labor force, reaching a low of just over 60 percent. Immediately after the lockdowns, the figure improved somewhat, but has been roughly stable for the past six months or so. Still the figure falls substantially short of its pre-COVID level.

Figure 1.7 contains a long-term view of the US workforce participation rate since 1980. Labor force participation for the US peaked in the late-1990s at 67 percent, before sliding to around 63 percent during much of the late-2010s. The participation rate

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 over five 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 continued improvement and the figure currently stands at around 380 thousand, around 40 percent above its pre-pandemic level.

Figure 1.8 shows the initial number of people receiving unemployment insurance benefits each week since the beginning of 2019. Prior to the pandemic, claims average around 230,000 per week but peaked to a level of more than 5.3 million during the early ph

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. Further, the figure has shown noticeable improvement during the recent recovery but remains noticeably below its level from early-2020.

Figure 1.9 plots single-family and multifamily housing starts since the mid-2000s. Both categories of housing have trended higher since the 2010 or so, but after a dip in the initial phase of the pandemic, homebuilding has increased. Growth has been espec

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 continued recovery depends on public health matters, rather than economic matters. As illustrated in Figure 1.10, our forecast calls for continued rapid growth in GDP through the end of 2022, followed by return to the longer-run average rate of growth through the end of the recovery period.

Figure 1.10 illustrates the monthly movement in consumer confidence. After increasing steadily in the aftermath of the Great Recession, US consumer confidence fell markedly in early-2020 due to the pandemic. Although the level remains well below pre-COVID

EMPLOYMENT and UNEMPLOYMENT OUTLOOK Our employment outlook is illustrated in Figure 1.11. The forecast calls for employment to continue to recover over the remainder of 2021 and over the course of 2022, with a return to the pre-pandemic level of employment by the middle to latter part of the year. This will be followed by a much slower rate of growth through the latter part of the forecast period. In Figure 1.12 we present the forecast for the unemployment rate. The forecast calls for a rate of just above five percent by the end of 2021. Further, we expect continued improvement over the course of 2022, with a return unemployment seen prior to the pandemic by the end of 2022. If employment continues to recover as expected the recovery from the recent recession will be much faster than the recovery from the last three US recessions.

Figure 1.11 provides a graph of real GDP growth over the past five years compared to the forecast level of growth during the next five years (through 2026). Growth is expected to remain well above long-term averages as the economy recovers from the COVID-

Figure 1.12 illustrates the recent historical levels of employment as well as the forecast path of employment during the 2021 to 2026 outlook period. The US has recovered nearly 70 percent of the jobs lost during the early part of the pandemic. Full recov

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 2001 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 in 2020 and 2021 have increased the figure once again, now to a level just above 100 percent of GDP. This places the figure at its highest level in history in with the exception of brief episodes during the Civil War, the Great Depression, and World War II. The figure is expected to remain high throughout the forecast period depicted. 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.

Figure 1.13 contains a line graph of the traditional unemployment rate. The US unemployment rate has dropped significantly since April 2020 and as of the third quarter 2021, has fallen to around 6 percent. The forecast calls for the national jobless rate

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 16 percent. Recent aggressive stimulus efforts have dramatically increased the figure further, placing it at a recent high of 24 percent for 2020. 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 eventually fall to around 18 percent by some time in 2022, but this still places the figure well above historic norms.

Figure 1.14 charts the movement of the US federal debt held by the public relative to overall GDP. Debt has risen considerably since the Great Recession compared to the overall economy, but the COVID-19 pandemic response led to a sharp increase that will

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 74 percent of all federal spending in 2020. Although this figure is exacerbated by a few percentage points for 2020 due to the year’s recession, we have observed 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.

Figure 1.15 provides a long-term view of the size of federal safety net programs relative to overall personal income. Transfer payments skyrocketed during 2020 and early-2021 as the federal government provided direct payments to households, expanded unemp

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 few exceptions for the past decade or so, up until the COVID-19 recession. 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 through 2019. COVID has caused major supply chain and broader economic disruptions in various ways that have led to a sharp spike in inflation in recent months. However, this spike is expected to dissipate as the economy returns to normal over the next year or so and then to remain modest or on target throughout the forecast. 

Figure 1.16 is a pie chart that breaks down the current share of federal spending accounted for by mandatory, nondefense discretionary spending and defense spending. Mandatory accounts for nearly three-fourths of federal spending as of 2020.

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 is not expected to translate into higher long run inflation, as stated. But inflationary pressures will eventually have the potential to build as lending and the broader economy continue to 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 dramatically in 2020 and aggressively again lowered interest rates again in order to provide new stimulus to the economy. Although rates are expected to remain very low until at least 2024, 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 provides a two-line chart that compares the measured rate of inflation overall as well as core inflation, which excludes more volatile components of food and energy. After remaining below the Federal Reserveís targeted inflation rate for much

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 2019 The second lowest-income fifth of households earned around 8 of the total income in the nation in 2019, and so on. The highest-income quintile earned nearly 52 percent of the nation’s total income in 2019. 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, 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.

Figure 1.18 contains three lines corresponding to different interest rates ñ the federal funds rate, 10-year Treasurys, and the 30-year conventional mortgage rates. Each type of interest rate is at or close to historic lows, but are expected to increase i

Figure 1.19 compares the level of real household income for the top 5 percent of versus that of the over median household. The chart shows that the median income high-earning households has more than doubled in real terms since the early-1970s while the m

Figure 1.20 shows the overall share of aggregate household income by quintile and households in the top 20 percent have earned an increasingly larger share of household income ñ surpassing more than 50 percent in recent years. Shares of earned income for