The Economist: What will the next decade bring?
The Business Cycle Dating Committee of the National Bureau of Economic Research, the group charged with dating recessions and recoveries, met in April and announced it did not yet have enough data to determine whether the recession is over.
Despite the common belief that a recession occurs when output contracts for two quarters and the recovery begins when output starts to grow, the reality is far more complicated. The NBER looks at dozens of indicators before making its determination, usually months after the turning point in the business cycle.
There are two theories about the cause of the recent recession. One is that it was simply bad luck and could have been avoided if we had regulated financial institutions more rigorously and cracked down on subprime mortgage lending earlier. The second is that there were huge bubbles in spending, credit, housing and the stock market and that it was inevitable they would burst, with disastrous consequences.
The causes underlying the Great Recession are important because they determine the outlook for the next few years. If it was simply lack of regulation, complicated by greed and a dollop of dishonesty in the financial sector, then the problems can be addressed through tougher regulation, and the economy can quickly return to the robust consumer spending and rising home prices of the last decade.
If the period from the mid-1990s through 2007 was an anomaly, dangerously dependent on consumer borrowing and spending, then the next decade will be marked by a painful transition to more reasonable levels of spending and borrowing. I have argued for several years that we cannot forever spend more than we earn, either as individuals or as a nation. That puts me firmly in the second camp.
I believe the data support my view.
• Between 1997 and 2007, per-person spending on goods and services grew four percentage points faster than income and seven percentage points faster than output.
• Inflation-adjusted per-person debt increased by 80 percent.
• Inflation-adjusted mortgage debt per person almost doubled.
• Consumer spending, which accounted for 65 percent of growth during the 1988-1997 decade, constituted 82.5 percent during 1998-2007.
• Government spending contributed 14 percent to economic growth, double the previous decade.
It seems clear the behavior of consumers and government during the last decade is not sustainable. It required us to borrow from abroad at a level not seen since the early 19th century. Our current account deficit doubled as a percentage of output between 1997 and 1999 and then doubled again by 2006.
While I am a strong proponent of the advantages of international trade, our current specialization in consumer spending, borrowing and the provision of sophisticated financial services is not sustainable. It is critical we save more so we can invest more in productive capacity, producing more goods and services to trade with the rest of the world. Only then will we return to a path of balanced, sustainable growth.
Bill Emmons at the Federal Reserve Bank of St. Louis has looked carefully at the last decade and developed three scenarios for the next one. The most optimistic involves global cooperation to rebalance world output and demand. Leaders and ordinary citizens in many countries work together to refocus their economies on sustainable domestic production and consumption. Profligate consumers learn to spend within their means, while overly thrifty consumers in developing economies avoid accumulating excess savings.
A second scenario looks at global imbalances returning because of the lack of coordinated policy adjustment. The most pessimistic scenario examines no policy adjustments and premature withdrawal of macroeconomic support, leading to a return of the global slump.
One can make a good argument for any of the three scenarios – although I fear that the second or third is the most likely outcome.