c h a p t e r 1 TO RESCUE, REBALANCE, economic AND REBUILDwelvitchia.com/Novidades_files/USA_The...

1

c h a p t e r 1

TO RESCUE, REBALANCE, AND REBUILD

transmitted to the congress february 2010

together with the annual report of the council of economic advisers

e c o n o m i c r e p o r t

o f t h e

p r e s i d e n t

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ISBN 978-0-16-084824-7

transmitted to the congressfebruary 2010

together withthe annual report

of thecouncil of economic advisers

united states government printing officewashington : 2010

e c o n o m i c r e p o r t

o f t h e

p r e s i d e n t

iii

C O N t e N t S

eCONOMIC RePORt OF tHe PReSIDeNt ........................................... 1

ANNUAL RePORt OF tHe COUNCIL OF eCONOMIC ADVISeRS* 11

CHAPteR 1. tO ReSCUe, ReBALANCe, AND ReBUILD .............. 25

CHAPteR 2. ReSCUING tHe eCONOMY FROM tHe GReAt ReCeSSION ........................................................................ 39

CHAPteR 3 CRISIS AND ReCOVeRY IN tHe WORLD eCONOMY ........................................................................ 81

CHAPteR 4. SAVING AND INVeStMeNt ....................................... 113

CHAPteR 5. ADDReSSING tHe LONG-RUN FISCAL CHALLeNGe ..................................................................... 137

CHAPteR 6. BUILDING A SAFeR FINANCIAL SYSteM .............. 159

CHAPteR 7. ReFORMING HeALtH CARe ...................................... 181

CHAPteR 8. StReNGtHeNING tHe AMeRICAN LABOR FORCe ................................................................................. 213

CHAPteR 9. tRANSFORMING tHe eNeRGY SeCtOR AND ADDReSSING CLIMAte CHANGe ............................ 235

CHAPteR 10. FOSteRING PRODUCtIVItY GROWtH tHROUGH INNOVAtION AND tRADe ................. 259

ReFeReNCeS ............................................................................................... 285

APPeNDIX A. RePORt tO tHe PReSIDeNt ON tHe ACtIVItIeS OF tHe COUNCIL OF eCONOMIC ADVISeRS DURING 2009 ...................... 305

APPeNDIX B. StAtIStICAL tABLeS ReLAtING tO INCOMe, eMPLOYMeNt, AND PRODUCtION ....................... 319

____________*For a detailed table of contents of the Council’s Report, see page 15.

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economic reportof the

president

economic Report of the President | 3

economic report of the president

to the Congress of the United States:

As we begin a new year, the American people are still experiencing the effects of a recession as deep and painful as any we have known in generations. traveling across this country, I have met countless men and women who have lost jobs these past two years. I have met small business owners struggling to pay for health care for their workers; seniors unable to afford prescriptions; parents worried about paying the bills and saving for their children’s future and their own retirement. And the effects of this recession come in the aftermath of a decade of declining economic security for the middle class and those who aspire to it.

At the same time, over the past two years, we have also seen reason for hope: the resilience of the American people who have held fast—even in the face of hardship—to an unrelenting faith in the promise of our country.

It is that determination that has helped the American people overcome difficult periods in our Nation’s history. And it is this persever-ance that remains our great strength today. After all, our workers are as productive as ever. American businesses are still leaders in innovation. Our potential is still unrivaled. Our task as a Nation—and our mission as an Administration—is to harness that innovative spirit, that productive energy, and that potential in order to create jobs, raise incomes, and foster economic growth that is sustained and broadly shared. It’s not enough to move the economy from recession to recovery. We must rebuild the economy on a new and stronger foundation.

I can report that over the past year, this work has begun. In the coming year, this work continues. But to understand where we must go in the next year and beyond, it is important to remember where we began one year ago.

4 | economic Report of the President

Last January, years of irresponsible risk-taking and debt-fueled speculation—unchecked by sound oversight—led to the near-collapse of our financial system. We were losing an average of 700,000 jobs each month. Over the course of one year, $13 trillion of Americans’ household wealth had evaporated as stocks, pensions, and home values plummeted. Our gross domestic product was falling at the fastest rate in a quarter century. the flow of credit, vital to the functioning of businesses large and small, had ground to a halt. the fear among economists, from across the political spectrum, was that we could sink into a second Great Depression.

Immediately, we took a series of difficult steps to prevent that catastrophe for American families and businesses. We acted to get lending flowing again so ordinary Americans could get financing to buy homes and cars, to go to college, and to start businesses of their own; and so businesses, large and small, could access loans to make payroll, buy equip-ment, hire workers, and expand. We enacted measures to stem the tide of foreclosures in our housing market, helping responsible homeowners stay in their homes and helping to stop the broader decline in home values.

to achieve this, and to prevent an economic collapse, we were forced to use authority enacted under the previous Administration to extend assistance to some of the very banks and financial institutions whose actions had helped precipitate the turmoil. We also took steps to prevent the collapse of the American auto industry, which faced a crisis partly of its own making, to prevent another round of widespread job losses in an already fragile time. these decisions were not popular, but they were necessary. Indeed, the decision to stabilize the financial system helped to avert a larger catastrophe, and thanks to the efficient management of the rescue—with added transparency and accountability—we have recovered most of the money provided to banks.

In addition, even as we worked to address the crises in our banking sector, in our housing market, and in our auto industry, we also began attacking our economic crisis on a broader front. Less than one month after taking office, we enacted the most sweeping economic recovery package in history: the American Recovery and Reinvestment Act of 2009. the Recovery Act not only provided tax cuts to small businesses and 95 percent of working families and provided emergency relief to those out of work or without health insurance; it also began to lay a new foundation for long-term growth. With investments in health care, education, infra-structure, and clean energy, the Recovery Act has saved or created roughly two million jobs so far, and it has begun the hard work of transforming our economy to thrive in the modern, global era.


Because of these and other steps, we can safely say that we’ve avoided the depression many feared. Our economy is growing again, and the growth over the last three months was the strongest in six years. But while economic growth is important, it means nothing to somebody who has lost a job and can’t find another. For Americans looking for work, a good job is the only good news that matters. And that’s why our work is far from complete.

It is true that the steps we have taken have slowed the flood of job losses from 691,000 per month in the first quarter of 2009 to 69,000 in the last quarter. But stemming the tide of job loss isn’t enough. More than 7 million jobs have been lost since the recession began two years ago. this represents not only a terrible human tragedy, but also a very deep hole from which we’ll have to climb out. Until jobs are being created to replace those we’ve lost—until America is back at work—my Administration will not rest and this recovery will not be finished.

that’s why I am continuing to call on the Congress to pass a jobs bill. I’ve proposed a package that includes tax relief for small businesses to spur hiring, that accelerates construction on roads, bridges, and waterways, and that creates incentives for homeowners to invest in energy efficiency, because this will create jobs, save families money, and reduce pollution that harms our environment.

It is also essential that as we promote private sector hiring, we continue to take steps to prevent layoffs of critical public servants like teachers, firefighters, and police officers, whose jobs are threatened by State and local budget shortfalls. to do otherwise would not only worsen unemployment and hamper our recovery; it would also undermine our communities. And we cannot forget the millions of people who have lost their jobs. the Recovery Act provided support for these families hardest-hit by this recession, and that support must continue.

At the same time, long before this crisis hit, middle-class families were under growing strain. For decades, Washington failed to address fundamental weaknesses in the economy: rising health care costs, growing dependence on foreign oil, an education system unable to prepare all of our children for the jobs of the future. In recent years, spending bills and tax cuts for the very wealthiest were approved without paying for any of it, leaving behind a mountain of debt. And while Wall Street gambled without regard for the consequences, Washington looked the other way.

As a result, the economy may have been working for some at the very top, but it was not working for all American families. Year after year, folks were forced to work longer hours, spend more time away from their


loved ones, all while their incomes flat-lined and their sense of economic security evaporated. Growth in our country was neither sustained nor broadly shared. Instead of a prosperity powered by smart ideas and sound investments, growth was fueled in large part by a rapid rise in consumer borrowing and consumer spending.

Beneath the statistics are the stories of hardship I’ve heard all across America—hardships that began long before this recession hit two years ago. For too many, there has long been a sense that the American dream—a chance to make your own way, to work hard and support your family, save for college and retirement, own a home—was slipping away. And this sense of anxiety has been combined with a deep frustration that Washington either didn’t notice, or didn’t care enough to act.

these weaknesses have not only made our economy more susceptible to the kind of crisis we have been through. they have also meant that even in good times the economy did not produce nearly enough gains for middle-class families. typical American families saw their stan-dards of living stagnate, rather than rise as they had for generations. that is why, in the aftermath of this crisis, and after years of inaction, what is clear is that we cannot go back to business as usual.

that is why, as we strive to meet the crisis of the moment, we are continuing to lay a new foundation for prosperity: a foundation on which the middle class can prosper and grow, where if you are willing to work hard, you can find a good job, afford a home, send your children to world-class schools, afford high-quality health care, and enjoy retirement security in your later years. this is the heart of the American Dream, and it is at the core of our efforts to not only rebuild this economy—but to rebuild it stronger than before. And this work has already begun.

Already, we have made historic strides to reform and improve our education system. We have launched a Race to the top in which schools are competing to create the most innovative programs, especially in math and science. We have already made college more affordable, even as we seek to increase student aid by ending a wasteful subsidy that serves only to line the pockets of lenders with tens of billions of taxpayer dollars. And I’ve proposed a new American Graduation Initiative and set this goal: by 2020, America will once again have the highest proportion of college grad-uates in the world. For we know that in this new century, growth will be powered not by what consumers can borrow and spend, but what talented, skilled workers can create and export.

Already, we have made historic strides to improve our health care system, essential to our economic prosperity. the burdens this system


places on workers, businesses, and governments is simply unsustainable. And beyond the economic cost—which is vast—there is also a terrible human toll. that’s why we’ve extended health insurance to millions more children; invested in health information technology through the Recovery Act to improve care and reduce costly errors; and provided the largest boost to medical research in our history. And I continue to fight to pass real, meaningful health insurance reforms that will get costs under control for families, businesses, and governments, protect people from the worst practices of insurance companies, and make coverage more affordable and secure for people with insurance, as well as those without it.

Already, we have begun to build a new clean energy economy. the Recovery Act included the largest investment in clean energy in history, investments that are today creating jobs across America in the industries that will power our future: developing wind energy, solar technology, and clean energy vehicles. But this work has only just begun. Other countries around the world understand that the nation that leads the clean energy economy will be the nation that leads the global economy. I want America to be that nation. that is why we are working toward legislation that will create new incentives to finally make renewable energy the profitable kind of energy in America. It’s not only essential for our planet and our security, it’s essential for our economy.

But this is not all we must do. For growth to be truly sustainable—for our prosperity to be truly shared and our living standards to actually rise—we need to move beyond an economy that is fueled by budget deficits and consumer demand. In other words, in order to create jobs and raise incomes for the middle class over the long run, we need to export more and borrow less from around the world, and we need to save more money and take on less debt here at home. As we rebuild, we must also rebalance. In order to achieve this, we’ll need to grow this economy by growing our capacity to innovate in burgeoning industries, while putting a stop to irre-sponsible budget policies and financial dealings that have led us into such a deep fiscal and economic hole.

that begins with policies that will promote innovation throughout our economy. to spur the discoveries that will power new jobs, new busi-nesses—and perhaps new industries—I have challenged both the public sector and the private sector to devote more resources to research and development. And to achieve this, my budget puts us on a path to double investment in key research agencies and makes the research and experi-mentation tax credit permanent. We are also pursuing policies that will help us export more of our goods around the world, especially by small


businesses and farmers. And by harnessing the growth potential of inter-national trade—while ensuring that other countries play by the rules and that all Americans share in the benefits—we will support millions of good, high-paying jobs.

But hand in hand with increasing our reliance on the Nation’s ingenuity is decreasing our reliance on the Nation’s credit card, as well as reining in the excess and abuse in our financial sector that led large firms to take on extraordinary risks and extraordinary liabilities.

When my Administration took office, the surpluses our Nation had enjoyed at the start of the last decade had disappeared as a result of the failure to pay for two large tax cuts, two wars, and a new entitlement program. And decades of neglect of rising health care costs had put our budget on an unsustainable path.

In the long term, we cannot have sustainable and durable economic growth without getting our fiscal house in order. that is why even as we increased our short-term deficit to rescue the economy, we have refused to go along with business as usual, taking responsibility for every dollar we spend. Last year, we combed the budget, cutting waste and excess wher-ever we could, a process that will continue in the coming years. We are pursuing health insurance reforms that are essential to reining in deficits. I’ve called for a fee to be paid by the largest financial firms so that the American people are fully repaid for bailing out the financial sector. And I’ve proposed a freeze on nonsecurity discretionary spending for three years, a bipartisan commission to address the long-term structural imbal-ance between expenditures and revenues, and the enactment of “pay-go” rules so that Congress has to account for every dollar it spends.

In addition, I’ve proposed a set of common sense reforms to prevent future financial crises. For while the financial system is far stronger today than it was one year ago, it is still operating under the same rules that led to its near-collapse. these are rules that allowed firms to act contrary to the interests of customers; to hide their exposure to debt through complex financial dealings that few understood; to benefit from taxpayer-insured deposits while making speculative investments to increase their own profits; and to take on risks so vast that they posed a threat to the entire economy and the jobs of tens of millions of Americans.

that is why we are seeking reforms to empower consumers with the benefit of a new consumer watchdog charged with making sure that financial information is clear and transparent; to close loopholes that allowed big financial firms to trade risky financial products like credit defaults swaps and other derivatives without any oversight; to identify


system-wide risks that could cause a financial meltdown; to strengthen capital and liquidity requirements to make the system more stable; and to ensure that the failure of any large firm does not take the economy down with it. Never again will the American taxpayer be held hostage by a bank that is “too big to fail.”

through these reforms, we seek not to undermine our markets but to make them stronger: to promote a vibrant, fair, and transparent finan-cial system that is far more resistant to the reckless, irresponsible activities that might lead to another meltdown. And these kinds of reforms are in the shared interest of firms on Wall Street and families on Main Street.

these have been a very tough two years. American families and businesses have paid a heavy price for failures of responsibility from Wall Street to Washington. Our task now is to move beyond these failures, to take responsibility for our future once more. that is how we will create new jobs in new industries, harnessing the incredible generative and creative capacity of our people. that is how we’ll achieve greater economic security and opportunity for middle-class families in this country. that is how in this new century we will rebuild our economy stronger than ever before.

the white housefebruary 2010

the annual reportof the

council of economic advisers

13

letter of transmittal

Council of economic AdvisersWashington, D.C., February 11, 2010

Mr. President:the Council of economic Advisers herewith submits its 2010

Annual Report in accordance of the employment Act of 1946 as amended by the Full employment and Balanced Growth Act of 1978.

Sincerely,

Christina D. Romer Chair

Austan Goolsbee Member

Cecilia elena Rouse Member

15

C O N t e N t S

Chapter 1. to resCue, rebalanCe, and rebuild .......... 25

Rescuing an economy in Freefall ............................................. 26Rescuing.the.Economy.from.the.Great.Recession.......................... . 28Crisis.and.Recovery.in.the.World.Economy.................................. . 29

Rebalancing the economy on the Path to Full employment ....................................................................................... 29

Saving.and.Investment.................................................................... . 29Addressing.the.Long-Run.Fiscal.Challenge................................... . 31Building.a.Safer.Financial.System................................................. . 32

Rebuilding a Stronger economy ............................................... 33Reforming.Health.Care................................................................... . 33Strengthening.the.American.Labor.Force...................................... . 35Transforming.the.Energy.Sector.and.Addressing.Climate..Change............................................................................................. . 36Fostering.Productivity.Growth.Through.Innovation.and..Trade................................................................................................ . 37

Conclusion ......................................................................................... 38

Chapter 2. resCuing the eConomy From the great reCession ................................................................................. 39

An economy in Freefall ................................................................ 39The.Run-Up.to.the.Recession.......................................................... . 40The.Downturn................................................................................. . 41Wall.Street.and.Main.Street........................................................... . 44

the Unprecedented Policy Response ....................................... 46Monetary.Policy.............................................................................. . 47Financial.Rescue.............................................................................. . 49Fiscal.Stimulus................................................................................. . 51Housing.Policy................................................................................. . 55

the effects of the Policies ......................................................... 56

Page

16 | Annual Report of the Council of economic Advisers

The.Financial.Sector......................................................................... 57Housing.............................................................................................. 60Overall.Economic.Activity................................................................ 63The.Labor.Market............................................................................. 68

the Challenges Ahead ................................................................... 72Deteriorating.Forecasts..................................................................... 72The.Administration.Forecast............................................................ 75Responsible.Policies.to.Spur.Job.Creation....................................... 78

Conclusion .......................................................................................... 79

Chapter 3. Crisis and reCovery in the World eConomy .................................................................................................. 81

International Dimensions of the Crisis ................................. 82Spread.of.the.Financial.Shock.......................................................... 82The.Collapse.of.World.Trade........................................................... 87The.Collapse.in.Financial.Flows...................................................... 89The.Decline.in.Output.Around.the.Globe....................................... 90

Policy Responses Around the Globe ......................................... 93Monetary.Policy.in.the.Crisis........................................................... 93Central.Bank.Liquidity.Swaps.......................................................... 96Fiscal.Policy.in.the.Crisis.................................................................. 98Trade.Policy.in.the.Crisis.................................................................. 100

the Role of International Institutions ................................. 100The.G-20............................................................................................ 100The.International.Monetary.Fund................................................... 101

the Beginning of Recovery Around the Globe .................... 102The.Impact.of.Fiscal.Policy............................................................... 104The.World.Economy.in.the.Near.Term........................................... 106Global.Imbalances.in.the.Crisis........................................................ 108

Conclusion .......................................................................................... 111

Chapter 4. saving and investment ...................................... 113

the Path of Consumption Spending ....................................... 114The.Determinants.of.Saving............................................................. 115Implications.for.Recent.and.Future.Saving.Behavior..................... 117

the Future of the Housing Market and Construction ..................................................................................... 120

The.Housing.Market......................................................................... 121

Contents | 17

Commercial.Real.Estate.................................................................... 123Business Investment ........................................................................ 126

Investment.in.the.Recovery............................................................... 126Investment.in.the.Long.Run............................................................. 127

the Current Account .................................................................... 129Determinants.of.the.Current.Account............................................. 129The.Current.Account.in.the.Recovery.and.in.the.Long.Run.......... 132Steps.to.Encourage.Exports............................................................... 133

Conclusion .......................................................................................... 135

Chapter 5. addressing the long-run FisCal Challenge ............................................................................................... 137

the Long-Run Fiscal Challenge ................................................ 137Sources.of.the.Long-Run.Fiscal.Challenge....................................... 139The.Role.of.the.Recovery.Act.and.Other.Rescue.Operations.......... 143

An Anchor for Fiscal Policy ....................................................... 144The.Effects.of.Budget.Deficits........................................................... 145Feasible.Long-Run.Fiscal.Policies..................................................... 146The.Choice.of.a.Fiscal.Anchor.......................................................... 148

Reaching the Fiscal target ......................................................... 149General.Principles............................................................................. 149Comprehensive.Health.Care.Reform............................................... 150Restoring.Balance.to.the.Tax.Code.................................................. 151Eliminating.Wasteful.Spending........................................................ 155

Conclusion: the Distance Still to Go .................................... 156

Chapter 6. building a saFer FinanCial system ............ 159

What Is Financial Intermediation? .......................................... 160The.Economics.of.Financial.Intermediation................................... 160Types.of.Financial.Intermediaries.................................................... 163

the Regulation of Financial Intermediation in the United States ..................................................................................... 166Financial Crises: the Collapse of Financial Intermediation .................................................................................. 170

Confidence.Contagion....................................................................... 170Counterparty.Contagion................................................................... 172Coordination.Contagion................................................................... 173

Preventing Future Crises: Regulatory Reform .................. 174


Promote.Robust.Supervision.and.Regulation.of.Financial..Firms.................................................................................................. 175Establish.Comprehensive.Regulation.of.Financial.Markets........... 176Provide.the.Government.with.the.Tools.It.Needs.to.Manage.Financial.Crises................................................................................. 178Raise.International.Regulatory.Standards.and.Improve.International.Cooperation................................................................ 179Protect.Consumers.and.Investors.from.Financial.Abuse............... 179

Conclusion .......................................................................................... 180

Chapter 7. reForming health Care ..................................... 181

the Current State of the U.S. Health Care Sector .......... 182Rising.Health.Spending.in.the.United.States.................................. 182Market.Failures.in.the.Current.U.S..Health.Care.System:..Theoretical.Background.................................................................... 185System-Wide.Evidence.of.Inefficient.Spending............................... 188Declining.Coverage.and.Strains.on.Particular.Groups.and..Sectors................................................................................................. 191

Health Policies enacted in 2009 ................................................ 196Expansion.of.the.CHIP.Program...................................................... 197Subsidized.COBRA.Coverage........................................................... 197Temporary.Federal.Medical.Assistance.Percentage.(FMAP)..Increase.............................................................................................. 199Recovery.Act.Measures.to.Improve.the.Quality.and.Efficiency..of.Health.Care................................................................................... 201

2009 Health Reform Legislation ................................................ 202Insurance.Market.Reforms:..Strengthening.and.Securing..Coverage............................................................................................. 202Expansions.in.Health.Insurance.Coverage.Through.the..Exchange............................................................................................ 205Economic.and.Health.Benefits.of.Expanding.Health..Insurance.Coverage........................................................................... 206Reducing.the.Growth.Rate.of.Health.Care.Costs.in.the.Public..and.Private.Sectors............................................................................ 207The.Economic.Benefits.of.Slowing.the.Growth.Rate.of.Health..Care.Costs.......................................................................................... 210

Conclusion .......................................................................................... 211

Contents | 19

Chapter 8. strengthening the ameriCan labor ForCe ........................................................................................... 213

Challenges Facing American Workers ................................... 214Unemployment.................................................................................. 214Sectoral.Change................................................................................. 216Stagnating.Incomes.for.Middle-Class.Families............................... 217

Policies to Support Workers ....................................................... 219education and training: the Groundwork for Long-term Prosperity .................................................................... 221

Benefits.of.Education........................................................................ 221Trends.in.U.S..Educational.Attainment.......................................... 222U.S..Student.Achievement................................................................ 226

A Path toward Improved educational Performance ....... 227Postsecondary.Education.................................................................. 228Training.and.Adult.Education......................................................... 229Elementary.and.Secondary.Education............................................. 231Early.Childhood.Education.............................................................. 233

Conclusion .......................................................................................... 234

Chapter 9. transForming the energy seCtor and addressing Climate Change ........................................... 235

Greenhouse Gas emissions, Climate, and economic Well-Being .......................................................................................... 236

Greenhouse.Gases.............................................................................. 237Temperature.Change......................................................................... 238Impact.on.Economic.Well-Being...................................................... 239

Jump-Starting the transition to Clean energy .................. 243Recovery.Act.Investments.in.Clean.Energy..................................... 243Short-Run.Macroeconomic.Effects.of.the.Clean.Energy..Investments........................................................................................ 246

Other Domestic Actions to Mitigate Climate Change .................................................................................................. 247Market-Based Approaches to Advance the Clean energy transformation and Address Climate Change .... 248

Cap-and-Trade.Program.Basics....................................................... 248Ways.to.Contain.Costs.in.an.Effective.Cap-and-Trade..System................................................................................................. 250


Coverage.of.Gases.and.Industries..................................................... 253The.American.Clean.Energy.and.Security.Act................................ 254

International Action on Climate Change Is Needed ........ 255Partnerships.with.Major.Developed.and.Emerging..Economies.......................................................................................... 256Phasing.Out.Fossil.Fuel.Subsidies.................................................... 257

Conclusion .......................................................................................... 257

Chapter 10. Fostering produCtivity groWth through innovation and trade .......................................... 259

the Role of Productivity Growth in Driving Living Standards ............................................................................................ 261

Recent.Trends.in.Productivity.in.the.United.States........................ 262Sources.of.Productivity.Growth........................................................ 264

Fostering Productivity Growth through Innovation..... 266The.Importance.of.Basic.Research................................................... 267Private.Research.and.Experimentation........................................... 269Protection.of.Intellectual.Property.Rights........................................ 270Spurring.Progress.in.National.Priority.Areas................................. 272Increasing.Openness.and.Transparency.......................................... 272

trade as an engine of Productivity Growth and Higher Living Standards .............................................................. 274

The.United.States.and.International.Trade.................................... 275Sources.of.Productivity.Growth.from.International.Trade............ 276Encouraging.Trade.and.Enforcing.Trade.Agreements................... 280

ensuring the Gains from Productivity Growth Are Widely Shared .......................................................................... 282Conclusion .......................................................................................... 284

reFerenCes .............................................................................................. 285

appendixes A. Report to the President on the Activities of the Council of economic Advisers During 2009 ................................................... 305 B. Statistical tables Relating to Income, employment, and Production ....................................................................................... 319

Contents | 21

list of figures 1-1. House Prices Adjusted for Inflation ............................................. 27 1-2. Monthly Change in Payroll employment .................................... 28 1-3. Personal Consumption expenditures as a Share of GDP .......... 30 1-4. Actual and Projected Budget Surpluses in January 2009 under Previous Policy ..................................................................... 31 1-5. Real Median Family Income .......................................................... 33 1-6. total Compensation Including and excluding Health Insurance ........................................................................................... 34 1-7. Mean Years of Schooling by Birth Cohort ................................... 36 1-8. R&D Spending as a Percent of GDP ............................................. 37 2-1. House Prices Adjusted for Inflation ............................................. 40 2-2. Income and Consumption Around the 2008 tax Rebate ......... 42 2-3. teD Spread and Moody’s BAA-AAA Spread through December 2008 ................................................................................. 43 2-4. Assets on the Federal Reserve’s Balance Sheet ............................ 48 2-5. teD Spread and Moody’s BAA-AAA Spread through December 2009 ................................................................................. 57 2-6. S&P 500 Stock Price Index ............................................................. 58 2-7. Monthly Gross SBA 7(a) and 504 Loan Approvals .................... 60 2-8. 30-Year Fixed Rate Mortgage Rate ............................................... 61 2-9. FHFA and LoanPerformance National House Price Indexes ... 63 2-10. Real GDP Growth ............................................................................ 64 2-11. Real GDP: Actual and Statistical Baseline Projection ............... 65 2-12. Contributions to Real GDP Growth ............................................. 66 2-13. Average Monthly Change in employment .................................. 68 2-14. estimated effect of the Recovery Act on employment .............. 69 2-15. Contributions to the Change in employment ............................. 71 2-16. Okun’s Law, 2000-2009 ................................................................... 74 3-1. Interbank Market Rates .................................................................. 83 3-2. Nominal trade-Weighted Dollar Index ....................................... 85 3-3. OeCD exports-to-GDP Ratio ....................................................... 87 3-4. Vertical Specialization and the Collapse in trade ...................... 88 3-5. Cross-Border Gross Purchases and Sales of Long-term Assets ................................................................................................. 90 3-6. Industrial Production in Advanced economies .......................... 91 3-7. Industrial Production in emerging economies .......................... 92 3-8. Headline Inflation, 12-Month Change ......................................... 93 3-9. Policy Rates in economies with Major Central Banks ............... 94


3-10. Change in Central Bank Assets ..................................................... 95 3-11. Central Bank Liquidity Swaps of the Federal Reserve ................ 97 3-12. tax Share and Discretionary Stimulus ......................................... 99 3-13. Outperforming expectations and Stimulus ................................. 105 3-14. OeCD Countries: GDP and Unemployment ............................. 108 3-15. Current Account Deficits or Surpluses ........................................ 110 4-1. Personal Consumption expenditures as a Share of GDP .......... 114 4-2. Personal Saving Rate Versus Wealth Ratio .................................. 115 4-3. Personal Saving Rate: Actual Versus Model ............................... 118 4-4. Actual Personal Saving Versus Counterfactual Personal Saving ................................................................................................. 119 4-5. Single-Family Housing Starts ......................................................... 121 4-6. Homeownership Rate ...................................................................... 122 4-7. Fixed Investment in Structures by type ...................................... 124 4-8. Commercial Real estate Prices and Loan Delinquencies .......... 125 4-9. Nonstructures Investment as a Share of Nominal GDP ............ 128 4-10. Saving, Investment, and the Current Account as a Percent of GDP ............................................................................................... 132 4-11. Growth of U.S. exports and Rest-of-World Income: 1960-2008 .......................................................................................... 134 5-1. Actual and Projected Budget Surpluses in January 2009 under Previous Policy ..................................................................... 138 5-2. Actual and Projected Government Debt Held by the Public under Previous Policy ..................................................................... 139 5-3. Budgetary Cost of Previous Administration Policy ................... 141 5-4. Causes of Rising Spending on Medicare, Medicaid, and Social Security .................................................................................. 142 5-5. Budget Comparison: January 2001 and January 2009 .............. 143 5-6. effect of the Recovery Act on the Deficit ..................................... 144 5-7. top Statutory tax Rates ................................................................. 153 5-8. evolution of Average tax Rates .................................................... 154 6-1. Financial Intermediation: Saving into Investment .................... 161 6-2. Financial Sector Assets .................................................................... 163 6-3. Share of Financial Sector Assets by type ..................................... 164 6-4. Confidence Contagion .................................................................... 171 6-5. Counterparty Contagion ................................................................ 173 6-6. Coordination Contagion ................................................................ 174 7-1. National Health expenditures as a Share of GDP ...................... 183 7-2. total Compensation Including and excluding Health Insurance ........................................................................................... 184

Contents | 23

7-3. Child and Infant Mortality Across G-7 Countries ..................... 190 7-4. Insurance Rates of Non-elderly Adults ........................................ 192 7-5. Percent of Americans Uninsured by Age ..................................... 193 7-6. Share of Non-elderly Individuals Uninsured by Poverty Status .................................................................................................. 194 7-7. Medicare Part D Out-of-Pocket Costs by total Prescription Drug Spending ................................................................................. 195 7-8. Share Uninsured among Adults Aged 18 and Over ................... 198 7-9. Monthly Medicaid enrollment Across the States ....................... 200 8-1. Unemployment and Underemployment Rates ........................... 214 8-2. Unemployment Rates by Race ....................................................... 215 8-3. Real Median Family Income and Median Individual earnings ............................................................................................ 218 8-4. Share of Pre-tax Income Going to the top 10 Percent of Families ............................................................................................. 219 8-5. total Wage and Salary Income by educational Group ............. 222 8-6. Mean Years of Schooling by Birth Cohort ................................... 224 8-7. educational Attainment by Birth Cohort, 2007 .......................... 225 8-8. Long-term trend Math Performance ......................................... 227 9-1. Projected Global Carbon Dioxide Concentrations with No Additional Action ............................................................................ 238 9-2. Recovery Act Clean energy Appropriations by Category ......... 246 9-3. United States, China, and World Carbon Dioxide emissions .......................................................................................... 255 10-1. Non-Farm Labor Productivity and Per Capita Income ............. 261 10-2. Labor Productivity Growth since 1947 ........................................ 262 10-3. R&D Spending as a Percent of GDP ............................................. 270 10-4. exports as a Share of GDP ............................................................. 275 10-5. Intra-Industry trade, U.S. Manufacturing .................................. 278

list of tables 2-1. Cyclically Sensitive elements of Labor Market Adjustment ..... 70 2-2. Forecast and Actual Macroeconomic Outcomes ........................ 73 2-3. Administration economic Forecast .............................................. 75 3-1. 2009 Fiscal Stimulus as Share of GDP, G-20 Members ............. 98 3-2. Stimulus and Growth in Advanced G-20 Countries .................. 104 5-1. Government Debt-to-GDP Ratio in Selected OeCD Countries (percent) ......................................................................... 147


list of boxes 2-1. Potential Real GDP Growth ........................................................... 76 4-1. Unemployment and the Current Account ................................... 130 7-1. the Impact of Health Reform on State and Local Governments .................................................................................... 208 8-1. the Recession’s Impact on the education System ...................... 224 8-2. Community Colleges: A Crucial Component of Our Higher education System ............................................................... 230 9-1. Climate Change in the United States and Potential Impacts .... 240 9-2. expected Consumption Loss Associated with temperature Increase .............................................................................................. 241 9-3. the european Union’s experience with emissions trading .... 252 10-1. Overview of the Administration’s Innovation Agenda .............. 266

25

c h a p t e r 1

tO ReSCUe, ReBALANCe, AND ReBUILD

President Obama took office at a time of economic crisis. the recession that began in December 2007 had accelerated following the financial crisis in September 2008. By January 2009, 11.9 million people were unem-ployed and real gross domestic product (GDP) was falling at a breakneck pace. the possibility of a second Great Depression was frighteningly real.

In the first months of the Administration, the President and Congress took unprecedented actions to restore demand, stabilize financial markets, and put people back to work. Just 28 days after his inauguration, the President signed the American Recovery and Reinvestment Act of 2009, the boldest countercyclical fiscal stimulus in American history. the Financial Stability Plan, announced in February, included wide-ranging measures to strengthen the banking system, increase consumer and business lending, and stem foreclosures and support the housing market. these and a host of other actions stabilized the financial system, supported those most directly affected by the recession, and walked the economy back from the brink.

But the Administration always knew that stabilizing the economy would not be enough. the problems that led to the crisis were years in the making. Continued action will be necessary to return the economy to full employment. In the process, an important rebalancing will need to occur. For too many years, America’s growth and prosperity were fed by a boom in consumer spending stemming from rising asset prices and easy credit. the Federal Government had likewise been living beyond its means, resulting in large and growing budget deficits. And our regulatory system had failed to keep up with financial innovation, allowing risky practices to endanger the system and the economy. For this reason, the Administration has sought to help restore the economy to health on a foundation of greater investment, fiscal responsibility, and a well-functioning and secure financial system.

26 | Chapter 1

even this important rebalancing would not be sufficient. In addition to the problems that had set the stage for the crisis, long-term challenges had been ignored and the U.S. economy was failing at some of its central tasks. Our health care system was beset by steadily rising costs, and millions of Americans either had no health insurance at all or were unsure whether their coverage would be there when they needed it. Middle-class families had seen their real incomes stagnate during the previous eight years, while those at the top of the income distribution had seen their incomes soar. A failure to slow the consumption of fossil fuels had contributed to global warming and continued dependence on foreign oil. And a country built on its record of innovation was failing to invest enough in research and development.

the President has dedicated his Administration to dealing with these long-run problems as well. As the new decade opens, Congress has come closer than ever before to passing landmark legislation reforming the health insurance system. this legislation would make health insurance more secure for those who have it and affordable for those who do not, and it would slow the growth rate of health care costs. Over the past year, the Administration has also worked with Congress to make important new investments to sustain and improve K-12 education and community colleges, jump-start the transition to a clean energy economy, and spur innovation through increased research and development. these and numerous other initiatives will help to rebuild the American economy stronger than before and put us on the path to sustained growth and prosperity. enacting these policies will help to ensure that our children and grandchildren inherit a country as full of promise and as economically secure as ever in our history.

Rescuing an Economy in Freefall

In December 2007, the American economy entered what at first seemed likely to be a mild recession. As Figure 1-1 shows, real house prices (that is, house prices adjusted for inflation) had risen to unprecedented levels, almost doubling between 1997 and 2006. the rapid run-up in prices was accompanied by a residential construction boom and the proliferation of complex mortgages and mortgage-related financial assets. the fall of national house prices starting in early 2007, and the associated declines in the values of mortgage-backed and other related assets, led to a slowdown in the growth of consumer spending, increases in mortgage defaults and home foreclosures, significant strains on financial institutions, and reduced credit availability.

to Rescue, Rebalance, and Rebuild | 27

By early 2008, the economy was contracting. employment fell by an average of 137,000 jobs per month over the first eight months of 2008. Real GDP rose only anemically from the third quarter of 2007 to the second quarter of 2008.

then in September 2008, the character of the downturn worsened dramatically. the collapse of Lehman Brothers and the near-collapse of American International Group (AIG) led to a seizing up of financial markets and plummeting consumer and business confidence. Parts of the financial system froze, and assets once assumed to be completely safe, such as money-market mutual funds, became unstable and subject to runs. Credit spreads, a common indicator of credit market stress, spiked to unprecedented levels in the fall of 2008. the value of the stock market plunged 24 percent in September and October, and another 15 percent by the end of January. As Figure 1-2 shows, over the final four months of 2008 and the first month of 2009, the economy lost, on average, a staggering 544,000 jobs per month, the highest level of job loss since the demobilization at the end of World War II. Real GDP fell at an increasingly rapid pace: an annual rate of 2.7 percent in the third quarter of 2008, 5.4 percent in the fourth quarter of 2008, and 6.4 percent in the first quarter of 2009.

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1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009

Figure 1-1House Prices Adjusted for Inflation

Index (1900=100)

Sources: Shiller (2005); recent data from http://www.econ.yale.edu/~shiller/data/Fig2-1.xls.

28 | Chapter 1

Rescuing the Economy from the Great Recession thus, the first imperative of the new Administration upon taking

office had to be to turn around an economy in freefall. Chapter 2 describes the unprecedented policy actions the Administration has taken, together with Congress and the Federal Reserve, to address the immediate crisis. the large fiscal stimulus in the American Recovery and Reinvestment Act, the programs to stabilize financial markets and restart lending, and the policies to assist small businesses and distressed homeowners have all played a role in generating one of the sharpest economic turnarounds in post–World War II history. Real GDP is growing again, job loss has moderated greatly, house prices appear to have stabilized, and credit spreads have almost returned to normal levels. A wide range of evidence indicates that in the absence of the aggressive policy actions, the recession and the attendant suffering of ordinary Americans would have been far more severe and could have led to catastrophe.

Yet, because the economy’s downward momentum was so great and the barriers to robust growth from the weakened financial conditions of households and financial institutions are so strong, the economy remains distressed and many families continue to struggle. A change from freefall to growing GDP and moderating job losses is a dramatic improvement, but it is not nearly enough. Chapter 2 therefore also examines the challenges that

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Figure 1-2Monthly Change in Payroll Employment

Thousands, seasonally adjusted

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Source: Department of Labor (Bureau of Labor Statistics), Current Employment Statistics survey Series CES0000000001.


remain in achieving a full recovery. It discusses some possible additional measures to spur private sector job creation.

Crisis and Recovery in the World Economy In the early fall of 2008, there was hope that the impact of the crisis

on the rest of the world would be limited. those hopes were dashed during the months that followed. In the fourth quarter of 2008 and the first quarter of 2009, real GDP fell sharply—often at double-digit rates—in the United Kingdom, Germany, Japan, taiwan, and elsewhere. the surprisingly rapid spread of the downturn to the rest of the world reduced the demand for U.S. exports sharply, and so magnified our economic contraction.

the worldwide crisis required a worldwide response. Chapter 3 describes both the actions taken by individual countries and those taken through international institutions and cooperation. As described in the leaders’ statement from the September summit of the Group of twenty (G-20) nations, the result was “the largest and most coordinated fiscal and monetary stimulus ever undertaken” (Group of twenty 2009). Just as the actions in the United States have begun to turn the domestic economy around, these international actions appear to have put the worst of the global crisis behind us. But the firmness of the budding recovery varies consider-ably across countries, and significant challenges still remain.

Rebalancing the Economy on the Path to Full Employment

the path from budding recovery to full employment will surely be a difficult one. the problems that sowed the seeds of the financial crisis need to be dealt with so that the economy emerges from the recession with a stronger, more durable prosperity. there needs to be a rebalancing of the economy away from low personal saving and large government budget deficits and toward investment. Our financial system must be strengthened both to provide the lending needed to support the recovery and to reduce the risk of future crises.

Saving and Investmentthe expansion of the 2000s was fueled in part by high consumption.

As Figure 1-3 shows, the share of GDP that takes the form of consumption has been on a generally upward trend for decades and reached unprec-edented heights in the 2000s. the personal saving rate fell to exceptionally low levels, and trade deficits were large and persistent. A substantial amount

30 | Chapter 1

of the remainder of GDP took the form of housing construction, which may have crowded out other kinds of investment. Such an expansion is not just unstable, as we have learned painfully over the past two years. It also contributes too little to increases in standards of living. Low investment in equipment and factories slows the growth of productivity and wages.

Chapter 4 examines the transition from consumption-driven growth to a greater emphasis on investment and exports. It discusses the likelihood that consumers will return to saving rates closer to the postwar average than to the very low rates of the early 2000s. It also describes the Administration’s initiatives to encourage household saving. Greater personal saving will tend to encourage investment by helping to maintain low real interest rates. the increased investment will help to fill some of the gap in demand left by reduced consumption. Chapter 4 discusses additional Administration policies, such as investment tax incentives, designed to promote private investment. Higher saving relative to investment will reduce net interna-tional capital flows to the United States. Because net foreign borrowing must equal the current account deficit, lower net capital inflows imply a closer balance of exports and imports, which will help create further demand for American products. the Administration also supports aggressive export promotion measures to further increase demand for our exports. the end

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Figure 1-3Personal Consumption Expenditures as a Share of GDP

Percent

Source: Department of Commerce (Bureau of Economic Analysis), National Income and Product Accounts Table 1.1.10.


result of this rebalancing will be an economy that is more stable, more investment-oriented, and more export-oriented, and thus better for our future standards of living.

Addressing the Long-Run Fiscal ChallengeA key part of the rebalancing that must occur as the economy returns

to full employment and beyond involves taming the Federal budget deficit. Figure 1-4 shows the actual and projected path of the budget surplus based on estimates released by the Congressional Budget Office (CBO) in January 2009, just before President Obama took office. As the figure makes clear, the budget surpluses of the late 1990s turned to substantial deficits in the 2000s, and the deficits were projected to grow even more sharply over the next three decades. As discussed in Chapter 5, the change to deficits in the 2000s largely reflects policy actions that were not paid for, such as the 2001 and 2003 tax cuts and the introduction of the Medicare prescription drug benefit. the projection of steadily increasing future deficits is largely due to the continuation of the decades-long trend of rising health care costs.

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Figure 1-4Actual and Projected Budget Surpluses in January 2009 under Previous Policy

Percent of GDP

ProjectedActual

Note: CBO baseline surplus projection adjusted for CBO’s estimates of costs of continued war spending, continuation of the 2001 and 2003 tax cuts, preventing scheduled cuts in Medicare’s physician payment rates, and holding other discretionary outlays constant as a share of GDP.Sources: Congressional Budget Office (2009a, 2009b).

32 | Chapter 1

Chapter 5 describes the likely consequences of these projected deficits over time and the importance of restoring fiscal discipline. It also discusses the President’s plan for facing this challenge. A period of severe economic weakness is no time for a large fiscal contraction. Instead, the Nation must tackle the long-run deficit problem through actions that address the under-lying sources of the problem over time. the single most important step that can be taken to reduce future deficits is to adopt health care reform that slows the growth rate of costs without compromising the quality of care. In addi-tion, the President’s fiscal 2011 budget includes other significant measures, such as allowing President Bush’s tax cuts for the highest-income earners to expire, reforming international tax rules to discourage tax avoidance and encourage investment in the United States, and imposing a three-year freeze in nonsecurity discretionary spending; alongside a proposal for a bipartisan commission process to address the long-run gap between revenues and expenditures.

Building a Safer Financial System Risky credit practices both encouraged some of the imprudent rise in

consumption and homebuilding in the previous decade and set the stage for the financial crisis. Chapter 6 analyzes the role that financial intermediaries play in the economy and diagnoses what went wrong during the meltdown of financial markets. the crisis showed that the Nation’s financial regula-tory structure, much of which had not been fundamentally changed since the 1930s, failed to keep up with the evolution of financial markets. the current system provided too little protection for the economy from actions that could threaten financial stability and too little protection for ordinary Americans in their dealings with sophisticated and powerful financial insti-tutions and other providers of credit. Strengthening our financial system is thus a key element of the rebalancing needed to assure stable, robust growth.

Chapter 6 discusses financial regulatory modernization. What is needed is a system where capital requirements and sensible rules are set in a way to control excessive risk-taking; where regulators can consider risks to the system as a whole and not just to individual institutions; where institutions cannot choose their regulators; where regulators no longer face the unacceptable choice between the disorganized, catastrophic failure of a financial institution and a taxpayer-funded bailout; and where a dedicated agency has consumer protection as its central mandate. For this reason, the President put forward a comprehensive plan for financial regulatory reform last June and is working with Congress to ensure passage of these critical reforms this year.


Rebuilding a Stronger Economy

even before the crisis, the economy faced significant long-term challenges. As a result, it was doing poorly at providing rising standards of living for the vast majority of Americans. Figure 1-5 shows the evolution of before-tax real median family income since 1960. Beginning around 1970, slower productivity growth and rising income inequality caused incomes for most families to grow only slowly. After a half-decade of higher growth in the 1990s, the real income of the typical American family actually fell between 2000 and 2006.

A central focus of Administration policy both over the past year and for the years to come is to build a firmer foundation for the economy. the President is committed to policies that will raise living standards for all Americans.

Reforming Health Care Health care is a key challenge that long predates the current economic

crisis. the existing system has left many Americans who have health insur-ance inadequately covered, poorly protected against insurance industry

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Figure 1-5Real Median Family Income

2008 dollars

Notes: Income measure is total money income excluding capital gains and before taxes. Annual income deflated using CPI-U-RS. Source: Department of Commerce (Census Bureau), Current Population Survey, Annual Social and Economic Supplement, Historical Income Table F-12.

34 | Chapter 1

abuses, and fearful of losing the insurance they have. And it has left tens of millions of Americans with no insurance coverage at all. the system also delivers too little benefit at too high a cost. Comparisons across countries and, especially, across regions of the United States reveal large differences in health care spending that are not associated with differences in health outcomes and that cannot be fully explained by factors such as differences in demographics, health status, income, or medical care prices. these large differences in spending suggest that up to nearly 30 percent of health care spending could be saved without adverse health consequences. the unnec-essary growth of health care costs is eroding the growth of take-home pay and is central to our long-run fiscal challenges. these adverse effects will only become more severe if cost growth is not slowed.

to illustrate what could happen to workers’ earnings in the absence of reform, Figure 1-6 shows the historical and projected paths of real total compensation per worker (which includes nonwage benefits such as health insurance) and total compensation net of health insurance premiums. As health insurance premiums absorb a growing fraction of workers’ compen-sation, the remaining portion of compensation levels off and then starts to decline.

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Figure 1-6Total Compensation Including and Excluding Health Insurance

2008 dollars per person

Actual

Note: Health insurance premiums include the employee- and employer-paid portions. Sources: Actual data from Department of Labor (Bureau of Labor Statistics); Kaiser Family Foundation and Health Research and Educational Trust (2009); Department of Health and Human Services (Agency for Healthcare Research and Quality, Center for Financing, Access, and Cost Trends), 2008 Medical Expenditure Panel Survey-Insurance Component. Projections based on CEA calculations.


Chapter 7 describes the actions the Administration and Congress took in 2009 to begin the process of improvement, including an expansion of the Children’s Health Insurance Program to provide access to health care for millions of children and important investments in the modernization of the health care system through the Recovery Act. It also describes the key elements of successful health insurance reform and discusses the prog-ress that has been made on reform legislation. Successful reform involves making insurance more secure for those who have it and expanding coverage to those who lack it. It must include delivery system reforms, reductions in waste and improper payments in the Medicare system, and changes in consumer and firm incentives that will slow the growth rate of costs substan-tially, while maintaining and even improving quality. Slowing the growth rate of health care costs will have benefits throughout the economy: it will raise standards of living for families, help reduce the Federal budget deficit relative to what it otherwise would be, benefit state and local governments, and encourage job growth and improved macroeconomic performance.

Strengthening the American Labor Force American workers have suffered greatly in the current recession.

As described in Chapter 8, long-term unemployment is at record levels. the unemployment rate, which was 10 percent for the country as a whole in December, is far higher for blacks, Hispanics, and other demo-graphic groups. the decline in house prices has eroded the nest eggs that many Americans had been counting on for their retirement. the Administration has initiated many actions to help support workers and their families through the recession and beyond. these actions range from extended and expanded unemployment insurance, to measures to make health insurance more affordable, to initiatives to promote retirement saving.

American workers also face the persistent problem of stagnating incomes. A key determinant of growth in standards of living is the rate of increase in the education and skills of our workforce. More and more jobs require education and training beyond the high school level, along with the ability to complete tasks that are open-ended and interactive. But, as Figure 1-7 shows, the years of education U.S. workers have brought to the labor market have risen little in the past four decades. And, as is well known, U.S. students lag behind those from many other countries in their performance on standardized tests.

Chapter 8 describes the Administration’s initiatives to improve the skills of our workers. the Administration is pursuing reform to eliminate wasteful subsidies to student loan providers, the savings from which will fund

36 | Chapter 1

new investments in education. the Administration has proposed a major initiative to support and improve community colleges, which are a neglected but critical link in our education system. It has also proposed increasing Pell Grants, and is taking steps to simplify the student aid application process so that eligible students are no longer discouraged by a complicated process from even applying for aid. All of these actions will help to achieve one of the President’s key educational goals for the country—that the proportion of adults with a college degree be the largest in the world by 2020.

Transforming the Energy Sector and Addressing Climate ChangeClimate change and energy independence present a very different

long-run challenge. Continued reliance on fossil fuels is leading to the buildup of greenhouse gases in the atmosphere and is changing our climate. Left unaddressed, these trends will have increasingly severe consequences over time. What is more, the United States imports the majority of the oil it uses, much of it from sources that are potentially subject to disruption.

Chapter 9 analyzes how economic policy can play a critical role in moving the United States toward a clean energy economy that is less depen-dent on fossil fuels and fossil fuel imports. Slowing climate change requires

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Figure 1-7Mean Years of Schooling by Birth Cohort

Years of schooling

Year of 21 birthday

Notes: Years of schooling at 30 years of age. Methodology described in Goldin and Katz (2007).Sources: Department of Commerce (Bureau of the Census), 1940-2000 Census IPUMS, 2005 CPS MORG; Goldin and Katz (2007).

st


slowing the emission of greenhouse gases. A market-based approach, such as that supported by the Administration and currently working its way through Congress, can provide the signals needed to accomplish this slowing of emissions efficiently and with minimal disruptions.

the support for research and development (R&D) and incentives for investment in clean energy technologies and energy efficiency in the Recovery Act and the President’s budget, as well as in the energy and climate legislation, can help foster the transition to a clean energy economy and spur growth in vital new industries. these new industries have the potential to reinvigorate the American manufacturing sector and generate secure, high-quality jobs.

Fostering Productivity Growth Through Innovation and Trade the ultimate driver of growth in average standards of living is

productivity growth. Increased investment in capital and in the skills of our workforce are two important sources of that growth. Chapter 10 examines two other sources of productivity gains: innovation and international trade.

Innovation comes from many sources. But a central one is investment in R&D. Figure 1-8 shows the share of GDP devoted to R&D over the past 50 years. In the mid-1960s, R&D constituted a larger share of total spending

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Figure 1-8R&D Spending as a Percent of GDP

Percent

Note: Data for 2008 are preliminary. Sources: National Science Foundation, Science and Engineering Indicators 2010 Tables 4-1 and 4-7.

38 | Chapter 1

than it has in the past decade. And in some other countries, such as Korea, Sweden, and Japan, R&D spending is a larger fraction of GDP than in the United States. the President is committed to raising the share of output devoted to R&D to 3 percent, so that America can continue to be a leader in new technologies and American workers and businesses can benefit from more rapid economic growth.

through the Recovery Act and other measures, the Administration is investing both directly in basic scientific research and development and in the infrastructure to support that research. Most innovation, however, comes from the private sector. Here, the Administration is providing critical incentives for R&D both in general and in such vital areas as clean energy technologies. the Administration is also pursuing a wide range of policies to support the small businesses that contribute so much to technological progress—policies ranging from programs to maintain the flow of credit to small businesses to health insurance reform that will help level the playing field between small and large businesses.

Finally, international trade can be an important source of productivity growth and incentives for innovation. trade has the potential to allow the U.S. economy to expand output in areas where it is more productive and to enable higher-productivity firms to expand. Access to a world market encourages American firms to invest in the research needed to become tech-nological leaders. through these routes, a free and fair trade regime can play an important part in lifting living standards in the long run. But for trade to play this role, it is essential to enforce existing trade rules and pursue policies that ensure that the benefits of trade are widely shared.

Conclusion

the past year has been one of great challenge for all Americans. Nearly every family has been touched in some way by the fallout from the crisis in financial markets, the drying up of credit, and the rise in unem-ployment. these challenges, moreover, have come after a decade in which ordinary Americans have seen their living standards stagnate, their health insurance become less secure, and their environment deteriorate.

the rest of this Report describes in more detail the actions the President has taken to end the recession, foster stable growth by rebalancing production and demand, and rebuild the foundation of the American economy. More fundamentally, it describes the work that remains to be done to create the prosperous, dynamic economy the American people need and deserve.

39

c h a p t e r 2

ReSCUING tHe eCONOMY FROM tHe GReAt ReCeSSION

the first and most fundamental task the Administration faced when President Obama took office was to rescue an economy in freefall. In November 2008, employment was declining at a rate of more than half a million jobs per month, and credit markets were stretched almost to the breaking point. As the economy entered 2009, the decline accelerated, with job loss in January reaching almost three-quarters of a million. the President responded by working with Congress to take unprecedented actions. these steps, together with measures taken by the Federal Reserve and other finan-cial regulators, have succeeded in stabilizing the economy and beginning the process of healing a severely shaken economic and financial system. But much work remains. With high unemployment and continued job losses, it is clear that recovery must remain the key focus of 2010.

An Economy in Freefall

According to the National Bureau of economic Research, the United States entered a recession in December 2007. Unlike most postwar reces-sions, this downturn was not caused by tight monetary policy aimed at curbing inflation. Although economists will surely analyze this downturn extensively in the years to come, there is widespread consensus that its central precipitating factor was a boom and bust in asset prices, especially house prices. the boom was fueled in part by irresponsible and in some cases predatory lending practices, risky investment strategies, faulty credit ratings, and lax regulation. When the boom ended, the result was wide-spread defaults and crippling blows to key financial institutions, magnifying the decline in house prices and causing enormous spillovers to the remainder of the economy.

40 | Chapter 2

The Run-Up to the Recessionthe rise in house prices during the boom was remarkable. As Figure

2-1 shows, real house prices almost doubled between 1997 and 2006. By 2006, they were more than 50 percent above the highest level they had reached in the 20th century.

Stock prices also rose rapidly. the Standard and Poor’s (S&P) 500, for example, rose 101 percent between its low in 2002 and its high in 2007. that rise, though dramatic, was not unprecedented. Indeed, in the five years before its peak in March 2000, during the “tech bubble,” the S&P 500 rose 205 percent, while the more technology-focused NASDAQ index rose 506 percent.

the run-up in asset prices was associated with a surge in construc-tion and consumer spending. Residential construction rose sharply as developers responded to the increase in housing demand. From the fourth quarter of 2001 to the fourth quarter of 2005, the residential investment component of real GDP rose at an average annual rate of nearly 8 percent. Similarly, consumers responded to the increases in the value of their assets by continuing to spend freely. Saving rates, which had been declining since the early 1980s, fell to about 2 percent during the two years before the reces-sion. this spending was facilitated by low interest rates and easy credit, with household borrowing rising faster than incomes.

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1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009

Figure 2-1House Prices Adjusted for Inflation

Index (1900=100)

Sources: Shiller (2005); recent data from http://www.econ.yale.edu/~shiller/data/Fig2-1.xls.

Rescuing the economy from the Great Recession | 41

The DownturnHouse prices began to drop in some markets in 2006, and then

nationally beginning in 2007. this process was gradual at first, with prices measured using the LoanPerformance house price index declining just 3½ percent nationally between January and June 2007. Lenders had lent aggressively during the boom, often providing mortgages whose soundness hinged on continued house price appreciation. As a result, the compara-tively modest decline in house prices threatened large losses on subprime residential mortgages (the riskiest class of mortgages), as well as on the slightly higher-quality “Alt-A” mortgages. As the availability of mortgage credit tightened, the downward pressure on real estate prices intensified. National house prices declined 6 percent between June and December 2007.

the negative feedback between credit availability and the housing market weighed on household and business confidence, restraining consumer spending and business investment. Although residential construction led the slowdown in real activity through 2007, by early 2008 outlays for consumer goods and services and business equipment and software had decelerated sharply, and total employment was beginning to decline. Real gross domestic product (GDP) fell slightly in the first quarter of 2008.

In February 2008, Congress passed a temporary tax cut. Figure 2-2 shows real after-tax (or disposable) income and consumer spending before and after rebate checks were issued. Consumption was maintained despite a tremendous decline in household wealth over the same period. total household and nonprofit net worth declined 9.1 percent between June 2007 and June 2008. Microeconomic studies of consumer behavior in this episode confirm the role of the tax rebate in maintaining spending (Broda and Parker 2008; Sahm, Shapiro, and Slemrod 2009). the fact that real GDP reversed course and grew in the second quarter of 2008 is further tribute to the helpfulness of the policy. But, in part because of the lack of robust, sustained stimulus, growth did not continue.

Financial institutions had invested heavily in assets whose values were tied to the value of mortgages. For many reasons—the opacity of the instru-ments, the complexity of financial institutions’ balance sheets and their “off-balance-sheet” exposures, the failure of credit-rating agencies to accu-rately identify the riskiness of the assets, and poor regulatory oversight—the extent of the institutions’ exposure to mortgage default risk was obscured. When mortgage defaults rose, the result was unexpectedly large losses to many financial institutions.

In the fall of 2008, the nature of the downturn changed dramatically. More rapid declines in asset prices generated further loss of confidence in the ability of some of the world’s largest financial institutions to honor

42 | Chapter 2

their obligations. In September, the Lehman Brothers investment bank declared bankruptcy, and other large financial firms (including American International Group, Washington Mutual, and Merrill Lynch) were forced to seek government aid or to merge with stronger institutions. What followed was a rush to liquidity and a cascading of retrenchment that had many of the features of a classic financial panic.

Risk spreads shot up to extraordinary levels. Figure 2-3 shows both the teD spread and Moody’s BAA-AAA spread. the teD spread is the difference between the rate on short-term loans among banks and a safe short-term treasury interest rate. the BAA-AAA spread is the difference between the interest rates on high-grade and medium-grade corporate bonds. Both spreads rose dramatically during the heart of the panic. Indeed, one way to put the spike in the BAA-AAA spread in perspective is to note that the same spread barely moved during the Great Crash of the stock market in 1929, and rose by only about half as much during the first wave of banking panics in 1930 as it did in the fall of 2008.

the same loss of confidence shown by the rise in credit spreads translated into declining asset prices of all sorts. the S&P 500 declined 29 percent in the second half of 2008. Real house prices tumbled another 11 percent over the same period (see Figure 2-1). All told, household and

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Figure 2-2Income and Consumption Around the 2008 Tax Rebate

Billions of 2005 dollars, seasonally adjusted annual rate

Disposable Personal Income

Personal Consumption Expenditures

Sources: Department of Commerce (Bureau of Economic Analysis), National Income and Product Accounts Table 2.6, line 30, and Table 2.8.6, line 1.

Rescuing the economy from the Great Recession | 43

nonprofit net worth declined 20 percent between December 2007 and December 2008, or by about $13 trillion. Again, a useful way to calibrate the size of this shock is to note that in 1929, household wealth declined only 3 percent—about one-seventh as much as in 2008. this is another indica-tion that the shocks hitting the U.S. economy in 2008 were enormous.

the decline in wealth had a severe impact on consumer spending. this key component of aggregate demand, which accounts for roughly 70 percent of GDP and is traditionally quite stable, declined at an annual rate of 3.5 percent in the third quarter of 2008 and 3.1 percent in the fourth quarter. Some of this large decline may have also reflected the surge in uncertainty about future incomes. Not only did asset prices fall sharply, leading to the decline in wealth; they also became dramatically more vola-tile. the standard deviation of daily stock returns in the fourth quarter, for example, was 4.3 percentage points, even larger than in the first months of the Great Depression.

the financial panic led to a precip

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