[Economic Report of the President (2009)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]


 
Overview


The U.S. economy has proven itself remarkably resilient over the
past 8 years, having withstood a number of major shocks throughout
the period. During the last few months of 2008, however, the
economy encountered major shocks in the financial sector that it
could not shake off. Those financial shocks combined with other
factors—record high commodity prices earlier in the year,
natural disasters, and continued weakness in the housing
market—to cause the economy to contract modestly in the third
quarter and what appears to be a sharp decline in the fourth
quarter (see Chapters 1 and 2). The contraction will likely last
into early- or mid-2009. Despite rapid fiscal and monetary policy
action in response to weakening economic conditions, the economy
entered into recession at the end of 2007, ending 6 years of
expansion and a record 52 months of uninterrupted job growth.
Several factors contributed over many years to create the credit
difficulties that reached crisis proportions late in the year. The
magnitude of the crisis required unprecedented policy responses to
reduce the extent of the damage to the economy. These policy
actions have laid a foundation for a strong economic recovery early
in the term of the next Administration. Most market forecasts
suggest the weakness will continue in the first half of 2009,
followed by a recovery beginning in the second half of 2009 that
will gain momentum in 2010 and beyond.
Despite the risk that recent events may overshadow the many
positive developments of the past 8 years, there have been major
policy advances that have improved the long-term prospects of our
economy and strengthened its foundation. Much of this Report
examines the effects of pro-growth economic policies and market-
based reforms adopted during the Administration, as well as policy
considerations that will further improve the long-term position of
our economy and allow more Americans to realize the benefits of
economic expansion in the future.
Record-high energy prices in 2008 highlighted our economy’s
dependence on fossil fuels and underscored the need to diversify
our national energy portfolio. Although it will take time and major
technological breakthroughs to substantially reduce our dependence
on fossil fuels, the Administration has invested unprecedented
levels of Federal resources and adopted a number of policies that
have helped advance the economy’s transition to new sources
of energy while reducing local and regional pollutants in
responsible ways that do not threaten our economic well-being (see
Chapter 3).
Export performance was one of the bright spots in the economy over
the past several years, and played an important role in offsetting
other areas of weakness in the economy. The United States’s
continued commitment to open trade and investment policies will be
an important factor in maintaining the international
competitiveness and the dynamic nature of our economy (see Chapter
4). Lower tax rates have also contributed to economic performance
by easing the burden on labor and capital and enabling firms,
investors, and consumers to allocate resources more efficiently
(see Chapter 5). These policies, which contribute to the increased
flexibility of the economy, will be important in facilitating the
economic recovery going forward. There remains considerable
opportunity to strengthen our economic position by eliminating the
uncertainty surrounding tax relief that is scheduled to expire. In
addition, rising health care costs and spending on entitlement
programs are ongoing areas of concern, and the Administration has
offered reforms that could substantially lower costs and improve
our fiscal position (see Chapters 6 and 7). Education is essential
to future prosperity, and the Administration has taken several
steps to improve kindergarten through twelfth-grade education and
to make college more affordable (see Chapter 8). Finally, as
highlighted by the recent financial crisis, there are several areas
in which regulatory reforms are necessary and appropriate to
address market failures. The Administration has pursued market-
oriented regulatory reforms that favor individual choice over
Government decision making wherever appropriate, and this approach
has proven effective in addressing market failures without imposing
excessive costs on society or the economy (see Chapter 9).

Chapter 1: The Year in Review and the Years Ahead
Following 6 consecutive years of expansion of the U.S economy, the
pace of real GDP expansion slowed in the first half of 2008 and
turned negative in the second half. The Business Cycle Dating
Committee of the National Bureau of Economic Research declared that
the economy peaked in December of 2007, then began a recession that
continued throughout 2008. Falling house prices initiated a cascade
of problems that threatened the solvency of several major financial
institutions and resulted in a major decline in the stock market.
To respond to these problems, policymakers undertook a wide range
of fiscal and monetary policy actions. Chapter 1 reviews the
economic developments of 2008 and discusses the
Administration’s forecast for the years ahead. The key points
of Chapter 1 are:
 Real GDP likely declined over the four quarters of 2008,
ending	a 6-year run of positive growth, as the slow growth
in the first half of the year was eclipsed by what appears
to be a sharp decline in the fourth quarter.
 Financial distress, which first became evident in
mid-2007 in the market for mortgage-backed securities
(MBS), continued through 2008 and affected a variety of
markets. In the wake of the failure and near-
failure of several major financial institutions in September
2008, financial stresses increased sharply to levels not
seen during the post-World War II era.
 Payroll jobs declined during 2008, having peaked in December
of 2007. Employment losses averaged 82,000-per-month during
the first 8 months of 2008, before accelerating to a
420,000-per-month pace during the next 3 months. The
unemployment rate was at 5 percent rate though April--a low
rate by historical standards--but increased to 6.7
percent in November. Initial and continued claims for
unemployment insurance moved up sharply over the course
of the year.
 Energy prices dominated the movement of overall inflation
in the consumer price index (CPI), with large increases
through July, followed by a sharp decline during the latter
part of the year. Core consumer inflation (which excludes
food and energy inflation) edged down from 2.4 percent
during the 12 months of 2007 to a 1.9 percent annual
rate during the first 11 months of 2008. Food prices rose
appreciably faster than core prices.
 Nominal hourly compensation increased 2.8 percent during the
12 months through September 2008 (according to the
employment cost index), a gain that was undermined by the
rise in food and energy prices, so that real hourly
compensation fell 2 percent. In the long run, real
hourly compensation tends to increase with labor
productivity, although the correlation can be very loose
over shorter intervals. Nonfarm business productivity has
grown at an average annual rate of 2.6 percent since the
business cycle peak in 2001.
 An economic stimulus was proposed by the President in
January and passed by Congress in February, authorizing
about $113 billion in tax rebate checks to low-and
middle-income taxpayers and allowing 50 percent expensing
for business equipment investment. The stimulus likely
boosted GDP growth in the second and third quarters
above what it might have been otherwise, but its influence
faded by the end of the year.
 The Administration's forecast	calls for real GDP to
continue to fall in the first half of 2009, with the
major declines projected to be concentrated in the fourth
quarter of 2008 and the first quarter of 2009. An active
monetary policy and the Treasury's injection of assets
into financial institutions are expected to ease
financial stress and to lead to a rebound in the
interest-sensitive sectors of the economy in the second
half of 2009. Also supporting growth during 2009 is the
substantial recent drop in petroleum prices, which offsets
some of the effects of the recent decline in household
wealth. The unemployment rate is expected to increase to
an average of 7.7 percent for 2009. The expansion in
2010-11 is projected to be vigorous, bringing the
unemployment rate down to 5 percent by 2012.

Chapter 2: Housing and Financial Markets

In the summer of 2008, the disruptions in credit markets that began
in 2007 worsened to the point that the global financial system was
in crisis. The magnitude of the crisis required an unprecedented
response on the part of the Government to limit the extent of
damage to the economy and restore stability to the financial
system. Chapter 2 reviews the origins of the crisis, its
consequences, the Government’s response, and discusses
several policy challenges going forward. The key points of Chapter
2 are:
 The roots of the current global financial crisis began
in the late 1990s. A rapid increase in saving by developing
countries (sometimes called the ``global saving glut``)
resulted in a large influx of capital to the United
States and other industrialized countries, driving down
the return on safe assets. The relatively low yield on
safe assets likely encouraged investors to look for
higher yields from riskier assets, whose yields also went
down. What turned out to be an underpricing of risk across
a number of markets (housing, commercial real estate, and
leveraged buyouts, among others) in the United States and
abroad, and an uncertainty about how this risk was
distributed throughout the global financial system, set the
stage for subsequent financial distress.
 The influx of	inexpensive capital helped finance a housing
boom. House prices appreciated rapidly earlier in this
decade, and building increased to well-above historic
levels. Eventually, house prices began to decline with
this glut in housing supply.
 Considerable innovations in housing finance--the
growth of subprime mortgages and the expansion of the
market for assets backed by mortgages--helped fuel the
housing boom. Those innovations were often beneficial,
helping to make home ownership more affordable and
accessible, but excesses set the stage for later losses.
 The declining	value of mortgage-related assets has had
a disproportionate effect on the financial sector because
a large fraction of mortgage-related assets are held by
banks, investment banks, and other highly levered
financial institutions. The combination of leverage (the
use of borrowed funds) and, in particular, a reliance
on short-term funding made these institutions (both in the
United States and abroad) vulnerable to large mortgage
losses.
 Vulnerable institutions failed, and others nearly failed.
The remaining institutions pulled back from extending
credit to each other, and interbank lending rates
increased to unprecedented levels. The effects of the
crisis were most visible in the financial sector,
but the impact and consequences of the crisis are being
felt by households, businesses, and governments throughout
the world.
 The U.S. Government has undertaken a historic effort to
address the underlying problems behind the freeze in the
credit markets. These problems, the subject of much of
this chapter, are a sudden increase in the desire for
liquidity, a massive reassessment of risk, and a solvency
crisis for many systemically important institutions. The
Government has worked to preserve the stability
of the overall financial system by preventing the disorderly
failures of important financial institutions; taken
unprecedented action to boost liquidity in short-term
funding markets; provided substantial new protections for
consumers, businesses, and investors; and cooperated
closely with its international partners.
 Looking forward, the global financial crisis presents
several additional challenges for the U.S. Government.
Among them are the need to modernize financial regulation,
unwind temporary programs in an orderly fashion, and
develop long-term solutions for the government-sponsored
enterprises (privately-owned, publicly-chartered entities)
Fannie Mae and Freddie Mac.

Chapter 3: Energy and the Environment

Although fossil fuels will continue to constitute a large share of
the Nation's energy portfolio for some time, the
Administration has taken major steps to increase and diversify the
Nation's energy supply and to improve the environment. Since
2001, significant investments have been made to develop cleaner and
more reliable energy sources, and several regulatory changes are
expected to deliver dramatic improvements in air quality
nationwide. Chapter 3 reviews recent advances in energy and
environmental policy and discusses several challenges associated
with efforts to diversify the Nation's energy portfolio, to
increase energy security, and to reduce emissions related to
fossil-fuel based energy use. The key points of Chapter 3 are:
 Because of innovative	regulations promulgated	under
this Administration, there should be substantial
improvements in air quality over the next few decades.
Two rules that implemented cap-and-trade programs
in the electricity sector represent a significant step
in using cost-effective, market-oriented policy instruments
to dramatically reduce power plants' emissions of sulfur
dioxide, nitrogen oxide, and mercury.
 Despite widespread support for using market-based approaches
to achieve our environmental and energy policy goals going
forward, challenges remain in realizing the full potential
of these approaches.
 There	is an increasing need to reassess how well existing
laws can address the environmental problems associated
with fossil fuel use in more cost-effective ways. For
example, it may become increasingly costly to make
additional reductions in traditional air pollutants, and
existing statutes that focus on local or regional
pollutants were not designed to address global problems
such as greenhouse gas (GHG) emissions.
 Substantial reductions in global GHG emissions will require
participation by all large emitters (countries and sectors
within countries).

Chapter 4: The Benefits of Open Trade and Investment Policies

The United States has one of the most open economies in the world,
ranking very high in common measures of openness to trade and
investment. In the long run, the benefits that open economic
policies generate far outweigh the narrow, short-run perceived
benefits of protectionist or isolationist policies. The more
diffuse but larger benefits of open trade and investment policies
to the general economy are often difficult to discern, especially
in the short run, and are sometimes obscured by the more visible
effects of protectionist policies on favored groups. This chapter
discusses several key facts about trade and investment in the
United States, the benefits of free trade and open investment, and
the policies that the United States has taken to enhance both. The
key points of Chapter 4 are:
 Openness to trade and	investment has boosted U.S. economic
growth. Openness can also reduce the impact of shocks and
increase the resilience of the U.S. economy.
 The number of	U.S. free trade	agreements has increased
greatly during this Administration, and these agreements
have contributed to the growth in U.S. exports.
 Portfolio and	direct investments into	the United States
reached historic levels over the past decade, in part due
to the depth, diversity, and openness of U.S. financial
markets and the competitiveness of U.S. firms.
 The United States has	maintained an open investment policy,
facilitating foreign direct investment flows between the
United States and the world while addressing legitimate
national security concerns.
 U.S. development and trade initiatives, as well as U.S.
engagement in multilateral institutions such as the World
Trade Organization and the World Bank, have helped increase
growth and foster political and economic stability in
developing countries throughout the world.
 Continued commitment to open economic policies throughout
the world will help ensure continued economic gains for the
United States and the rest of the world.

Chapter 5: Tax Policy

Several policy changes over the past 8 years have resulted in lower
tax rates for both individuals and businesses, and specific
incentives have been established to reduce the adverse tax
consequences of certain desirable activities, such as running a
small business or buying an alternative-fuel vehicle. Lower tax
rates have increased the benefit of working and investing; in
particular, lower tax rates on dividends and capital gains helped
business investment expand, thereby helping firms increase worker
productivity. Tax relief has contributed to the solid economic
growth and job creation that prevailed over most of the past
several years. The expiration of these tax reductions would have
serious consequences for the U.S. economy. An additional challenge
is to further reduce business tax burdens to encourage business
investment in the United States in order to develop new jobs for
U.S. workers and to continue improving our standard of living. The
key points of Chapter 5 are:
 Taxes	alter individual and business incentives and thus
have the potential to distort their behavior. This
Administration consistently fought to reduce tax burdens on
individuals and businesses; tax rates are now much lower
than they were just 8 years ago.
 Tax reductions	over the past 8	years have improved
incentives to work, save, and invest.
 Globally, nations compete for businesses and the associated
jobs; the United States may need to reduce tax rates on
businesses to remain competitive in today's world.
 Future goals should include permanently extending the tax
relief of the past 8 years and reforming the Alternative
Minimum Tax.

Chapter 6: The Long-Run Challenges of Entitlement Spending

Federal spending on entitlement programs is expected to increase
dramatically in the coming decades, particularly for Social
Security, Medicare, and Medicaid. Taken together, these programs
currently constitute 45 percent of Federal non-interest spending,
and assuming no major changes to these programs, this share is
projected to rise dramatically in coming decades. An aging
population and rising health care spending per person are major
reasons for these projected increases. The primary objective of
this chapter is to highlight the budgetary challenges facing each
of the three major entitlement programs and to outline possible
strategies for addressing these challenges. The key points of
Chapter 6 are:
 Federal entitlement spending is on an unsustainable path.
Spending on the three major entitlement programs--Social
Security, Medicare, and Medicaid--is projected to increase
much faster than tax revenues or than the overall economy
over the coming decades. Paying all scheduled benefits
would eventually require substantial reductions in other
Government spending, or major tax increases, or both.
 The aging population is a major cause	of the expected
increase, especially for Social Security, representing a
permanent, as opposed to temporary, shift in the
entitlement landscape. Currently, one out of six adults is
age 65 or older; by 2020, one out of five adults will be
65 or older; and, by 2030, one out of four adults will be
age 65 or older.
 The pay-as-you-go financing structure	of Social Security,
coupled with the aging population, creates a sizeable
structural imbalance that will cause current and future
generations of workers to bear increasing costs or receive
smaller benefits than now scheduled, or both.
 Over the past 30 years, real per capita health care
spending has grown considerably faster than real gross
domestic product (GDP) per capita. Real growth in Medicare
spending is being driven by increasing enrollment, greater
utilization of more expensive high-technology medical
treatments, and expansion of the goods and services covered
by the program.
 Long-term care expenditures for low-income elderly and
disabled persons represent a large and growing share of
total Medicaid spending. The demand for long-term care is
expected to grow in the United States as a result of the
aging population. In turn, this will place even greater
financial strain on Federal and State budgets.

Chapter 7: Balancing Private and Public Roles in Health Care

Health care is one of the largest and fastest-growing sectors of
the U.S. economy. While modern health care provides substantial
benefits, there are growing concerns that its rising cost poses a
threat to Americans' access to health insurance and medical
care. The Administration has pursued several initiatives to
encourage the efficient provision of health care through private
markets and to improve access to affordable health care for
individuals in the United States. This chapter provides an overview
of U.S. performance with respect to the population's health
status and spending on health care and discusses key efforts by the
Administration to address issues of health care quality, cost, and
access. The key points of Chapter 7 are:
 Health care spending	is expected to grow rapidly over the
next	several decades, a trend that is driven by the
increased use of high-technology medical procedures,
comprehensive health insurance that decreases consumer
incentives to shop for cost-effective care, rising rates
of chronic disease, and the aging of the population in
the United States.
 Markets for health care services can function more
efficiently when payers, providers, and consumers have
more complete information as well as incentives to use
medical care that is clinically effective and of high
value.
 Health insurance improves individuals' well-being by
providing financial protection against uncertain medical
costs and by improving access to care. Market-based
approaches and innovative benefit designs can enable
people to select coverage that best fits their preferences
and to more actively participate in their own health care
decision making.
 The Federal Government has an important role	in investing
in public health infrastructure, particularly with respect
to improving the availability of community-based health
care for the underserved, preparing for possible public
health crises, supporting health-related research and
development, and promoting global health improvement.

Chapter 8: Education and Labor

Long-term economic growth requires a productive workforce with the
skills necessary to compete in a global labor market. The
Administration's commitment to maintaining the high
productivity of American workers is evident in successful education
and training policies. A continued commitment to broader access to
quality education and training will be required to meet the
increasing worldwide demand for highly skilled labor. A workforce
with better and more widely dispersed skills will ensure that
workers enjoy higher incomes and will be a force in reducing income
inequality in the United States. The United States also needs
comprehensive reform of its immigration policies. The key points of
this chapter are:
 Education benefits individuals through higher earnings, and
it benefits society as a whole. Administration initiatives
to improve kindergarten through twelfth-grade education,
most notably the No Child Left Behind Act, are demonstrating
clear, measureable results.
 Access to higher education was maintained through an
expanded Pell Grant program and proactive efforts that
helped protect Federally subsidized student loans from
recent credit issues faced elsewhere in the economy.
 Despite a small decline in real median household income,
which had begun prior to the Administration taking office,
hourly earnings of workers outpaced inflation, and real per
capita disposable income rose substantially during the past
8 years. Median household income increased steadily after
the recovery began in earnest in 2004. Also, pension
reforms were enacted to help protect retirement income.
 Income inequality and immigration reform must still be
addressed. Strong support for education and a focus on
workers' skills can help close income gaps. Reform of
immigration policies must provide border security while
allowing the economic benefits that immigrant labor provides
to the economy.

Chapter 9: Economic Regulation

The private enterprise system, supported by consistent enforcement
of laws protecting property and contracts, has been at the heart of
the American econ-omy's tremendous prosperity and growth.
Although free markets produce the most efficient outcome in most
cases, there are instances where government intervention can
increase economic efficiency. Government regulation can improve
economic outcomes where there are specific market failures that,
for example, create negative externalities that impose costs on
society or create harm from natural monopolies. At the same time,
the Government's ability to create efficient regulation is
limited and may create significant costs, which must be weighed
against the potential benefits of addressing market failures. This
chapter reviews several areas in which markets have been affected
by Government policy in the past 8 years. The key points of this
chapter are:
 Regulation is	appropriate when, and only when, there is an
important market failure that can be effectively addressed
by the Government. For example, the Administration has
taken steps to reduce restrictive regulation of broadband
markets, preserving an environment conducive to innovation
and new investment. Conversely, the Administration
supported new rules for financial reporting when
it became clear that existing laws did not adequately reduce
information asymmetries between investors and management.
 When the Government intervenes to address market failures,
it should attempt to take advantage of market-based
incentives whenever possible. The Administration has helped
ensure that scarce spectrum licenses are allocated more
efficiently by increasing the amount of bandwidth allocated
through auctions rather than through arbitrary allotments.
In transportation, the Administration has supported
market-based approaches to financing infrastructure such as
roads and the air traffic control system.
 The Administration has endeavored to ensure that, when the
government does intervene in markets, it does so in a way
that supports the operation of competitive markets. When
the market for terrorism insurance was disrupted following
the attacks of 9/11, the Administration supported a
temporary program of Federal support for terrorism
insurance, and the Administration has insisted that
subsidies be phased out as private insurers adapt and return
to the market. By supporting tort reform, the Administration
has helped reduce the scope for class action lawsuits that
create costs that outweigh their social benefits.