[Economic Report of the President (2011)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 2

The Year in Review and the Years Ahead

Following the deepest recession since the Great Depression, the U.S.
economy completed its sixth consecutive quarter of recovery at the end
of 2010. the recovery began in the second half of 2009 and the first
half of 2010, but real gross domestic product (GDP) then decelerated
around midyear before growth quickened again to 3.2 percent at an
annual rate in the fourth quarter of 2010 (Figure 2-1). Private sector
employment also decelerated during the summer, before picking up in
the fourth quarter. With the financial crisis now well behind us, and
considerable slack remaining in employment and resources, the U.S.
economy has tremendous potential to grow without reigniting inflation.


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DEVELOPMENTS IN 2010 AND THE NEAR-TERM OUTLOOK

Consumption and Saving

Consumer spending composes about 70 percent of GDP and, as is
typical, has been less volatile than the overall economy during this
recession and recovery. Consumption made up about 40 percent of the
decline in GDP during the recession and about 54 percent of the
recent rebound. Movements in this important component of spending
reflect changes in consumer sentiment, household wealth and income,
credit availability, government income support programs, and taxes.
Measures of consumer sentiment fell to their lowest levels of the
recession from November 2008 through February 2009 and rebounded
sharply through May 2010. Confidence slipped a few points around
midyear 2010 and then was roughly stable through October before
picking up toward the end of the year. Nevertheless, sentiment
remains well below pre-recession levels.

[

Stock market fluctuations closely parallel those of consumer sentiment
(Figure 2-2), with a few notable exceptions, such as during 2007, when
sentiment started falling a year earlier than the stock market did.
Nevertheless, sentiment and the stock market have shown similar
rebounds during the recovery, recapturing by December 2010, 95 percent
and 76 percent (respectively) of their recessionary decline since the
December 2007 business-cycle peak. thus, although sentiment and the
stock market sometimes move independently, both have supported the
2010 growth in consumer spending.


[

After consumer sentiment, a second prime determinant of consumer
spending is household wealth (also called net worth). As can be seen
in Figure 2-3, the consumption rate (the share of disposable income
consumed) tends to fluctuate with the wealth-to-income ratio. A one
dollar drop in wealth appears to reduce annual consumer spending by
two to four cents. the decline in the wealth-to-income ratio from
its 2007 average to its low point in the first quarter of 2009
amounted to 1.8 years of income. (In other words, household wealth
declined by the amount of income earned in 1.8 years.) this was the
deepest decline since compilation of these data began in 1952. Of
this 1.8 year-of-income decline, 1.1 years of income was lost from
stock market wealth, and about 0.6 year from housing wealth (net of
mortgage debt owed). (Components of wealth aside from stock market
wealth and housing wealth edged down slightly relative to income.)
Since 2009:Q1, the wealth-to-income ratio has recovered about 0.4
year of income, with the rebound entirely due to stock market gains
as housing and the other forms of wealth have edged a bit lower
relative to disposable income. After netting out this rebound, the
drop in wealth from 2007 through end-of-year 2010 has been about 1.3
years of income. A decline in wealth of this magnitude can be
expected to set off an adjustment process that raises the saving rate
by about 4.3 percentage points. With the saving rate having risen
from an average of 1.9 percent during 2005-07 to 5.8 percent in 2010,
the adjustment of personal saving to the lower level of household
net worth is now in line with the fundamentals, taking the historical
relationships as a guide.1
------------------------------------
1 the model was described in the 2010 Economic Report, pp. 117-20.

Another influence on consumer spending is the willingness of
financial institutions to lend to households. Households prepare for
lean times by saving out of regular income or by planning to draw on
bank credit such as credit cards. When bank credit becomes less
readily available, some households react by saving more so that they
can build up their buffer stocks, and other households, who had been
planning to draw on their credit lines, become unable to do so
because credit is not available. the sharp decline in banks'
willingness to lend during the recession (Figure 2-4) is among the
reasons why the saving rate increased. During 2010, however, the
Federal Reserve's Senior Loan Officers Survey shows that banks
became somewhat more willing to lend to consumers.

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Various income support programs have also likely influenced consumer
spending during the past year. extended unemployment benefits and
emergency unemployment benefits totaled $43 billion in 2009 and $65
billion in 2010, up from $8 billion in 2008. these benefits
stabilized consumer spending relative to the path that it would have
taken otherwise.
Consumer spending has also been sustained by other policies such as
the Making Work Pay (MWP) tax credit, which provides up to $400 ($800
for working married couples) for those with earned income up to
75,000 ($150,000 for couples), and progressively less for those with
income above these limits. For the economy as a whole, MWP lowered
tax liabilities (and boosted disposable income) by roughly $50
billion and $57 billion in calendar years 2009 and 2010, respectively.
For 2011, MWP is being replaced-by provisions of the tax Relief,
Unemployment Insurance Reauthorization, and Job Creation Act enacted
by Congress at the end of 2010 (discussed more fully later in this
Chapter). Provisions included a 2 percentage point, one-year reduction
in the payroll tax that funds Social Security, reducing tax
liabilities by about $112 billion. In addition, the new law supports
consumer spending by continuing the extension of unemployment
insurance through 2011. this new law was proposed, legislated, and
signed after the Administration economic forecast was finalized, and
so its effects are not included in that forecast.
Although purchases of durable goods, such as motor vehicles and
household appliances, are regarded as consumption in the national
income and product accounts, they can also be considered a form of
investment because they are long-lasting and provide services for the
duration of ownership. Consumer durable purchases are typically more
volatile than other purchases, declining faster than overall
consumption during a cyclical downturn and growing faster than overall
consumption during cyclical recovery periods (for example, durable
goods purchases grew at an 11.1 percent annual rate during the four
quarters of 2010). Rapid growth of durables purchases may pull down
the saving rate temporarily at some point during the early part of
the recovery.

Developments in Housing Markets
As shown in Figure 2-5, the CoreLogic home price index, a
comprehensive and closely watched measure of existing home prices,
dropped 32 percent from the peak of the housing market in April 2006
to the trough in March 2009, following the bursting of the housing
bubble that built up between 2002 and 2005. the United States had
never before suffered such a sharp drop in national house prices.
Although house prices fell about 30 percent in nominal terms during
the Great Depression, general price levels at that time fell 25
percent. As a result, the real house price decline during the Great
Depression was only about 7 percent. During the current episode, the
overall inflation rate has slowed but not turned negative, making
the recent decline in house prices far larger in real terms than
that during the Depression.

[

House prices have generally stabilized since March 2009, fluctuating
around a roughly flat trend line. Nonetheless, house prices have
been volatile over the past year, because of unusual market
conditions such as the large supply of distressed homes on the
market and the short-term impetus to demand from temporary tax
credits for homebuyers. Among the factors that continue to keep
sales and starts below their long-run trend levels are modest income
growth, slower household formation, and tighter mortgage underwriting
standards, as well as heightened uncertainty among potential
homebuyers and the large ``shadow inventory'' of foreclosed and other
distressed properties on (or soon to be on) the market.
The bursting of the housing bubble has posed serious challenges to
homeowners. Houses are typically leveraged assets (that is, financed
with debt); according to the Census Bureau's American Housing
Survey, about 68 percent of owner-occupied houses carry a mortgage.
Leverage amplifies the effects of price changes on household net
worth because price changes affect asset values while leaving
outstanding debt unchanged. Because mortgage debt does not change
when house prices fall, declines in prices cause even larger
declines in home equity (that is, the house value less total
mortgage debt). For example, the owner of a $100,000 house with an
$80,000 mortgage would have $20,000 in home equity. If prices fell
10 percent, the house would be worth $90,000 and home equity would
fall to $10,000-50 percent decline in equity from a 10 percent
decline in prices. the higher the leverage, the larger will be the
decline in home equity for a given decline in the value of the
house. For that reason, the 32 percent decline in house prices led
to a 56 percent decline in home equity, resulting in a loss of
about $7.5 trillion in net housing wealth over three years.
For many of the most highly leveraged household-in particular
those who bought their homes near the peak of the market with no or
low down payment-the decline in the value of their home was larger
than their equity, meaning that their houses were worth less than
their mortgages. Many of these underwater borrowers subsequently
defaulted on their mortgage payments, often because they could not
keep up with payments after losing income during the recession and
could not sell their homes for enough to cover the mortgage debt.
Although home prices in many parts of the country have stabilized,
about a quarter of homeowners with mortgages remain underwater.
total negative equity is estimated to be roughly $750 billion. In
the states with the highest shares of households underwater-Nevada,
Arizona, Florida, Michigan, and California-a third or more of
homeowners with mortgages have negative equity (in Nevada, the share
is about two-thirds). these homeowners are the most likely to
default on their loans: according to CoreLogic, the rate of
foreclosure initiation rises steadily as negative equity increases,
reaching about 14 percent for homeowners whose homes are worth less
than half their mortgage balance.
As Figure 2-6 shows, although the foreclosure rate fell in 2010,
it remains extraordinarily high by historical standards. the rate
has stayed high partly because of long lags in the foreclosure
timeline (a bank may take months or even years to resell a house
after its original owner defaults on the mortgage) and partly
because falling house prices exacerbated the recession, leading to
job losses that fed back into more foreclosures. Problems with
foreclosure paperwork that came to light last fall have contributed
to the slower rate of new foreclosures as lenders take extra time
to verify that foreclosures are properly documented.

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The Obama Administration, as well as the previous Administration
and the Federal Reserve, took extraordinary policy actions in
response to the enormous damage done by the collapse of housing
markets. In September 2008, to keep the flow of new mortgage credit
open, the treasury placed the government-sponsored enterprises
(GSes), Fannie Mae and Freddie Mac, into conservatorship and
committed sufficient capital to allow them to keep funding new
mortgages. the Federal Housing Administration (FHA) also ramped up
its lending substantially, offering new mortgages to many households
who could otherwise not obtain them. At the height of the boom, the
combined market share of the GSe, FHA, and Veterans Administration
loans was about 36 percent of new originations; today the share is
about 90 percent. Meanwhile, from early 2009 through the first
quarter of 2010, the Federal Reserve purchased $1.25 trillion-and
the treasury, more than $200 billion-of mortgage-backed securities
guaranteed by Fannie Mae, Freddie Mac, and the Government National
Mortgage Association (Ginnie Mae) on the open market, helping to
push mortgage rates to record low levels. Many households were thus
able to refinance their mortgages and reduce their monthly payments.
Nonetheless, weakness in the housing market has remained, resulting
in continued foreclosures. the Administration's housing programs,
including the Home Affordable Refinance Program (HARP), the Housing
Affordable Modification Program (HAMP), and funds allocated to state
and local housing finance agencies in the hardest-hit areas, have
helped many borrowers achieve more affordable mortgages, but the
housing market remains under stress in many areas, hampering the
economic recovery.

Business Fixed Investment

Overall nonresidential investment grew at a rapid 10 percent annual
rate during the four quarters of 2010, but its two main components
diverged sharply. equipment and software investment grew 16 percent,
while investment in nonresidential structures fell 6 percent.
More than a third of the growth in equipment and software investment
during 2010 was in information-processing equipment and software,
which grew 11 percent. A bit less than a third was in transportation
equipment, which grew 55 percent (with most of the strength in motor
vehicles). Investment in industrial equipment also grew notably, 15
percent (accounting for more than an eighth of equipment and software
investment growth).
Within the nonresidential structures category, investment in
buildings fell in 2010, but that decline was partially offset by
rapid growth of investment in structures for petroleum and natural
gas drilling (51 percent at an annual rate). Declines in the buildings
component were widespread, from health care facilities, to office
buildings, shopping centers, factories, and power generation plants.
Because of the long lead time required, investment in structures
tends to lag cyclical turning points.
Overall business investment may be poised to grow rapidly because
firms now appear to have plenty of internal funds. Corporate profits
have rebounded almost to their pre-recession level. As a result,
corporate cash flow, a measure of internal funds available for
investment that includes undistributed profits and depreciation, has
also risen substantially during the recovery. Ordinarily,
nonresidential investment exceeds corporate cash flow (Figure 2-7),
and the corporate sector as a whole must borrow to finance its
investments. (Noncorporate entities are also responsible for some
investment.) But because of the corporate sector's recent strong
growth, net corporate cash flow today is in the unusual position of
exceeding investment. A large share of these investable funds has
been channeled to financial investments rather than to new physical
capital, as can be seen by the rising level of liquid assets held by
nonfinancial corporations.

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Another contribution to investment growth is the forecast increase
in real GDP growth in 2011 because the level of investment is often
related to the growth rate of GDP. Also spurring investment during
2011 will be the provision of the tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act allowing full expensing for
tax purposes of equipment investment put in place during the year.

Business Inventories

Inventory investment played a large role in the initial stages of
recovery. Inventory investment-that is, the change in inventories-is
one of the components of GDP, so the change in inventory investment
(the change in the change in inventories) affects the growth of GDP.
Inventory investment was increasingly negative in the first and
second quarters of 2009 (the light blue bars in Figure 2-8), and the
inventory contribution to GDP growth was negative (the blue bars).
Inventory investment started to rise in the third quarter of 2009,
from a negative value to a less-negative one, and that rise
contributed positively to GDP growth through the third quarter of
2010. During the first three quarters of 2010, inventory investment

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contributed an average of 1.7 percentage points at an annual rate to
real GDP and accounted for more than half of the period's real GDP
growth. Inventory investment commonly accounts for a high share of
growth during the early stages of recovery.
By the third quarter, this recent increase in inventory investment
had raised the stock of inventories, returning it to a more normal
level relative to sales. the sharp fourth-quarter rise in final sales
(7.1 percent at an annual rate according to preliminary data)
exceeded the rise in production, and inventory investment dropped
off sharply, subtracting more than 3 percentage points from GDP.
Although inventories remain lean with respect to sales, they are
less so than they were earlier in the recovery (Figure 2-9) so that
inventory investment may play a smaller part in GDP growth over the
next year than it did during the past two years.

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Government Outlays, Consumption, and Investment

The Federal budget deficit on September 30, the end of fiscal year
2010, was $1.29 trillion, down about 8.5 percent from $1.41 trillion
the year before. As a share of GDP, the deficit fell from about 10
percent in FY 2009 to 8.9 percent in FY 2010. With the recovery
beginning to take hold, Federal receipts rose about 3 percent during
2010, while spending fell about 2 percent. Corporate tax receipts,
in particular, increased nearly 39 percent as taxable profits rose.
Despite their pickup in 2010, corporate tax receipts are still about
half what they were in FY 2007-a measure of the depth of the budget
hole created by the recession. Receipts from individual income taxes
and payroll taxes continued to fall in FY 2010, in part because of
lower labor market activity linked to the recession and in part
because of tax cuts for households implemented as part of the
Recovery Act of 2009.
The Recovery Act was enacted when U.S. real GDP was contracting at
an annual rate of more than 6 percent and employment was falling by
more than 700,000 jobs a month. the Recovery Act's spending
provisions, tax cuts, and aid to states and individuals were
designed to cushion the fall in demand caused by the financial
crisis and the subsequent decline in consumer and business
confidence, household wealth, and access to credit. As of the third
quarter of 2010, the Council of economic Advisers (CEA) estimates
that the Recovery Act has raised the level of GDP, relative to what
it otherwise would have been, by 2.7 percent and raised employment,
relative to what it otherwise would have been, by between 2.7
million and 3.7 million jobs.2
------------------------------------------
2 See CEA (2010b). the CEA uses two methods of estimating the impact
of the Recovery Act on employment. the multiplier approach yields 2.7
million jobs, while the statistical projection approach yields 3.7
million.

According to the Congressional Budget Office (CBO 2010), net
Federal outlays arising from the financial crisis-including the
troubled Assets Relief Program (TARP), Federal deposit insurance
payouts, and treasury payments to the government-sponsored
enterprises Fannie Mae and Freddie Mac-were $367 billion lower in
2010 than in 2009, because of lower spending and additional
repayments of TARP loans. Repayments by banks under TARP accounted
for a large share of the additional receipts. In 2009, the
Administration estimated that TARP would cost $341 billion. these
estimates have steadily decreased, and following recent developments
such as repayments from the insurance company AIG and sales of
government-owned shares of stock in General Motors and Citigroup,
the President's 2012 Budget estimates TARP's deficit cost will be
$48 billion. Recent estimates from the CBO are even lower. By
contrast, short-term recession-related spending increased during
2010; spending on defense and entitlement programs such as Social
Security and Medicare also rose, though at a slower pace than its
average over the past five years. Overall, spending fell from about
25 percent of GDP in 2009 to 23.8 percent in 2010. excluding
short-term expenditures, spending relative to GDP was about 21
percent in 2010, roughly the same as its average over the past 30
years.
Deficits are expected to decline quickly over the coming years as
the recovery picks up, short-term countercyclical measures wind
down, and the Administration's proposed budget cuts occur. As shown
in Figure 2-10, the Administration projects that the deficit as a
share of GDP will fall from 10.9 percent in FY 2011 to 4.6 percent
in FY 2013, and to 3.2 percent in FY 2015.
Nonetheless, major long-term fiscal challenges remain. even before
the financial crisis and ensuing recession, the long-run budget
outlook was problematic, in part because a series of policy choices
over the past decade had reduced projected revenue while increasing
projected spending. At the same time, trying to balance the budget
all at once would be counterproductive because the recovery of the
private sector is still fragile and would likely be imperiled by a
sharp and immediate fiscal contraction.

The 2010 tax Relief, Unemployment Insurance Reauthorization, and Job
Creation Act, passed in December 2010, extended tax cuts for all
Americans for two years. As a result of the new law, families will
not see their taxes increase in 2011 and 2012, as had been scheduled.
It also introduces a 2 percentage point payroll tax cut that will
provide about $112 billion of tax relief to working Americans in
2011. In addition, the new law continues the extension of
unemployment insurance so that workers who lost their job through
no fault of their own will continue to receive support through 2011.
together, the tax cuts and additional unemployment insurance
payments will boost consumption. the new law also introduces strong
incentives to firms to invest in 2011 by allowing them to expense
the full cost of their equipment investment.

[

In the absence of new tax legislation, the simultaneous expiration
of the Making Work Pay tax cuts and of the tax cuts enacted between
2001 and 2003 would have reduced real GDP growth over the four
quarters of 2011 by 0.9-2.8 percentage points, according to the
Congressional Budget Office (CBO 2011). the positive impact of the
new law exceeded what most private forecasters had been expecting
for fiscal policy, leading them to increase their estimates of 2011
growth. At the same time, the package is constructed to be temporary
(including one- and two-year provisions) so that its effect on the
long-term deficit is minimal.
Still, the need for medium- and long-term fiscal consolidation is
clear. For the medium term, President Obama has announced an
ambitious goal of cutting the deficit in half by 2013. to help meet
that target, the Administration has proposed a number of new
initiatives to help restore fiscal discipline, including a five-year
freeze on nonsecurity discretionary spending, a two-year freeze on
Federal wages, a slowdown in the growth of defense spending, and
eliminating earmarks from the appropriations process. these proposals
build on a number of steps that the Administration has already taken
to reduce deficits in coming years, the most important of which is
enactment of the Patient Protection and Affordable Care Act of 2009.
If the cost-control provisions of the law are followed over the next
several decades, they will have a profound effect on the budget. A
second critical step was the enactment of the Statutory Pay-As-You
-Go Act, which requires Congress to offset most spending increases
with tax increases or reduced spending elsewhere, an important move
toward fiscal responsibility. In addition, economic growth will
affect the long-run ratio of debt to GDP. Steps to spur that growth
are discussed in depth in Chapter 3.

State and Local Government

The operating deficit of state and local government has improved
during the recovery but remains precarious because of the severity
of the downturn. In addition, while funds from the Recovery Act
helped to support state and local revenues during 2009 and 2010,
that support is scheduled to diminish. the continuing distress is
evident from the 414,000 jobs that the sector lost between August
2008, the peak of state and local employment, and December 2010.
the state and local sector's direct contribution to real GDP growth
was negative during the four quarters of 2009 and remained so
through the first quarter of 2010. Its GDP contribution was close
to zero during the final three quarters of 2010.
State and local tax revenues reached a low point in the second
quarter of 2009 but then grew 8 percent for the five quarters
through the third quarter of 2010, recovering $103 billion, or most
of their nominal decline during the preceding four quarters. Almost
half of the recovery in tax receipts ($47 billion) came from
corporate taxes, a source that usually provides only about 4 percent
of state and local tax revenues. Sales and property taxes, by
contrast, grew more slowly than the overall economy. Federal
grants-in-aid (mostly for Medicaid and education) generally
increased during 2009 and 2010 because of the Recovery Act, which
provided a cumulative $147.1 billion in such grants through 2010:Q3.
Current state and local government expenditures-which include
transfers to individuals as well as government consumption-have
grown slowly since the business-cycle trough in the second quarter
of 2009, at a 3.0 percent annual rate through the third quarter of
2010, compared with a 4.0 percent growth rate of nominal GDP. the
combination of restrained spending growth, a recovery in tax
revenues, and increased Federal transfers moved the current
operating position of state and local governments from a maximum
deficit of $67 billion at an annual rate in the third quarter of
2008 to a surplus of $45 billion in the third quarter of 2010.
Real investment by state and local governments (which is not part
of current expenditures) fell over the four quarters of 2009 and the
first quarter of 2010 but edged up in the second and third quarters
of 2010. the gain in investment spending likely reflects the recent
increase in capital transfers for transportation under the Recovery
Act.
During 2011 and 2012, state and local governments will have to make
tough budget decisions. the sector is likely to show little spending
growth as Federal transfers diminish and past declines in house
prices restrain growth in the property tax base, which accounts for
about a third of tax collections. One point of relative strength in
the near term, however, is state and local construction spending
(for example, on roads and bridges), as the longer-lived portions
of the Recovery Act investments are translated into public
infrastructure capital.

Real Exports and Imports

Real exports grew 9 percent during the four quarters of 2010, a
rebound following a 3 percent contraction in 2008 and no change in
2009. the rebound coincides with a general recovery of non-U.S. GDP
beginning in mid-2009 (Figure 2-11). In addition to its sensitivity
to the economic strength of our trading partners, U.S. export
performance also reflects movements in relative prices across
countries. the broad index of the real value of the dollar rose
during the recession-compounding the effect of falling world
demand-but has generally fallen since March 2009, depreciating a
total of 3 percent during the 12 months of 2010.

[


Shrinking exports subtracted from GDP growth in each quarter
between 2008:Q3 and 2009:Q2, but real exports have added to GDP in
every quarter since, including adding 1.1 percent to real GDP growth
over the four quarters of 2010. In the coming years, a combination
of strong growth in many key export markets should allow for
continued growth in real exports (see Chapter 4 for a detailed
discussion of the recovery of U.S. exports).
Real imports grew 11 percent during the four quarters of 2010.
Although they grew faster than real exports, they had also fallen
more steeply than real exports during 2008 (6 percent) and 2009
(7 percent). the pattern in real imports parallels, but is sharper
than, the general shape of the contraction and rebound in overall
U.S. personal consumption spending. Because imports tend to be
concentrated more in goods than is overall consumer spending, real
imports move more closely with goods consumption-which is cyclically
sensitive-than with consumption overall. And because business
equipment investment includes imported capital goods, real imports
track this cyclically sensitive series as well.
Labor Market Trends
The recession's impact on the labor market was severe, and it will
take time before the labor market regains full strength. Figure 2-12
illustrates the pattern of employment (excluding jobs associated
with the decennial Census) from its peak for each of the previous
three recessions. the figure

[

shows that the first several months of job losses associated with
the 2007-09 recession (the dashed line) followed a pattern almost
identical to those of the two previous recessions, those of 1990-91
and 2001.3
-----------------------------------
3 Figures 2-12 and 2-13 show non-Census jobs. the Census hired and
subsequently laid off more than half a million temporary workers in
2010. these month-to-month changes affect headline numbers but are
less reflective of labor market fundamentals. thus, we exclude
Census jobs from this employment series.

Beginning in summer 2008, however, job losses became
more severe, resulting in a much longer and deeper recession.4
------------------------------
4 the official end date of the 2007ï¿½09 recession was June 2009, a
full 18 months after the recession officially began. In contrast,
both the 2001 and 1990-91 recessions officially lasted 8 months.

By the time President Obama took office in January 2009, the economy
was shedding more than 700,000 jobs a month, and employment reached
its trough in February 2010. Between the peak of employment in
January 2008 and the trough, the economy lost 8.75 million nonfarm
jobs-almost as many as were lost in the past three recessions
(1981-82, 1990-91, and 2001) combined, adjusting for growth in the
size of the economy. Job losses as a share of the economy were the
largest the United States has experienced in 65 years.
Despite these historic employment losses, sustained albeit modest
job growth began relatively quickly after the recession officially
ended. Figure 2-13 compares the path of non-Census employment
following this recession with those of the previous two recoveries,
normalized to the level of employment at the official end date of
each recession. As can be seen, job losses

[

continued after the end of each recession, with the most recent
recovery continuing to experience the deepest losses. However, in
the recovery from the 2007ï¿½09 recession (dashed line), non-Census
job growth began 9 months into the recovery and continued in each
month through December 2010 (the 18th month after the end of the
recession). By comparison, the 1990ï¿½91 recovery (light blue line)
was somewhat delayed, experiencing no net job creation until 12
months into the recovery. In sharp contrast, the 2001 recovery
(dark blue line) continued to lose jobs throughout the comparable
time period, and sustained job growth did not begin until 22 months
after the official end date of the recession. thus, while the 2007-
09 recession lasted longer and job losses were much deeper than in
either the recession of 1990ï¿½91 or 2001, recovery in the labor
market began sooner.
Beyond these trends, 2010 also saw improvements along other margins
of labor adjustment. Generally speaking, one would expect the
workweek and the use of temporary help to grow before total
employment begins to grow, because firms can lengthen the workweek
and use temporary help to increase labor input without having to
bear the fixed costs, such as benefits, associated with hiring a
permanent worker. During the recession, the workweek for production
and nonsupervisory employees lost 0.8 hour. However, it gained back
nearly two-thirds of that loss in the next 13 months, reaching 33.5
hours in July 2010, and maintained that level throughout the second
half of the year. this gain is important, because a 0.1 hour gain for
employed workers is roughly equivalent in terms of labor input to an
increase in employment of more than 300,000 jobs. Likewise,
temporary help services, which lost about 800,000 jobs during the
recession, began to grow toward the end of 2009 and saw strong gains
in 2010. the industry has now gained back more than half its losses.
Most important, private sector employment has grown in every month
since March of 2010, adding a total of 1.1 million jobs during 2010
and recording the strongest private sector job growth since 2006.
total nonfarm employment fared nearly as well, adding more than
900,000 jobs during 2010, though this job growth was tempered by a
loss of 243,000 jobs in local government.
However, it is clear that the economy still has a long way to go
before it fully recovers. Recessions resulting from a financial
crisis tend to be deeper than other types of recessions, and
recovery from them is more difficult (Reinhart and Reinhart 2010;
Reinhart and Rogoff 2009). State and local governments continue to
face substantial budget shortfalls that have led to cuts in public
sector employment. the national unemployment rate, which fell 0.7
percentage point from its peak to December, remains elevated, with
more than 6 million people in long-term unemployment (defined as
having been jobless and searching for work for 27 weeks or more) as
of December 2010.5
-------------------------------------------
5 the unemployment rate is a prominent, but incomplete, measure of
labor market well-being. If workers are encouraged or discouraged
by labor market conditions, they may enter or exit the labor force,
moving the unemployment rate in the opposite direction of the economy's momentum. However, thus far in the recession and recovery, other
measures of labor underutilization (for example, the employment-to-
population ratio or measures including those working part-time for
economic reasons) have shown patterns similar to the unemployment
rate.

Further, although the number of job seekers per
job opening had fallen to 4.7 in December (from a high of more than
6), it remains unacceptably high.
Policy Responses to Support the Labor Market. the Administration's
first major step in addressing the severe contraction of the labor
market was the Recovery Act, which kept the employment situation
from getting substantially worse. In fact, the CEA has previously
estimated that in the absence of the Recovery Act, non-Census
employment growth would not have begun until the third quarter of
2010 (or roughly 14 months from the official end date of the
recession; see Figure 2-13), which would have placed the current
recovery more in line with the slower employment responses of the
previous two recessions.
In addition, in March of 2010, President Obama signed the Hiring
Incentives to Restore employment (HIRe) Act, which cuts payroll
taxes for employers hiring workers who have been unemployed for at
least 60 days. the law contains two key provisions. First, it
exempted employers from paying their share of Social Security taxes
(6.2 percent of wages) on qualified workers hired from February 4,
2010 to December 31, 2010, and offset these losses to the Social
Security trust Fund with general fund revenues; this provision of
the law ended in 2010. Second, for each hire that is retained for
at least one year, the law gives the employer a general business tax
credit equal to 6.2 percent of that employee's yearly wages, up to
a maximum of $1,000. According to the Department of the treasury,
from February to November of 2010, an estimated 11.8 million workers
who had been unemployed for eight weeks or longer were hired,
qualifying their employers for the HIRe Act payroll tax exemption.
In August 2010, in response to the continuing job losses in state
and local government, the President signed the education Jobs and
Medicaid Assistance Act, which provided $10 billion to states to
prevent layoffs of teachers. According to CEA estimates, this
critical assistance supported 160,000 teacher jobs during the
2010-11 academic year.
In addition, the Administration made several efforts over the past
year to help small businesses and promote entrepreneurship. the
measures included passing numerous tax cuts for small business,
signing the Small Business Jobs Act, and launching Startup America
in early 2011. these policies are discussed in detail in Chapter 7.
All of these policy responses were designed to put jobless
Americans back in the workplace as quickly as possible, both for
their own well-being and also for that of the nation as a whole. the
labor market growth seen thus far is encouraging, especially
compared with the recoveries following the 1990-91 and 2001
recessions, but obviously is only a start. More robust job creation
is needed.
Prices
Price inflation as measured by the consumer price index excluding
food and energy (known as the core CPI) moved lower in 2010,
dropping to 0.8 percent from 1.8 percent during the two preceding
years. the GDP price index excluding food and energy edged up
slightly to a still-low 1.1 percent. (the GDP price index is the
broadest index of what is produced in the United States including
investment, exports, and government services in addition to consumer
goods and services.)
There have been higher rates of inflation at some early stages of
goods processing, but restrained growth of unit labor costs arising
from a combination of low capacity utilization, elevated
unemployment, and strong productivity growth have overwhelmed other
influences as commodities are processed and moved down the supply
chain toward the final consumer. Further, these commodity and
materials prices make up only a small share of overall goods prices.
Labor costs now make up about 58 percent of costs in the nonfarm
business sector, and labor costs per unit of real output fell in
2009 and 2010.
The Administration's inflation forecast reflects three balancing
forces: persistent downward pressure on inflation from the high
levels of economic slack, a further expected pickup in economic
growth, and fairly stable inflation expectations. the
Administration's projected rise in CPI inflation to 1.4 percent in
2011 moves in the direction expected by the consensus of
professional forecasters.

Financial Markets
From December 2009 through December 2010, stock market values rose,
and yields on treasury notes fell, but the movements were volatile
in both cases. Long-term interest rates fell during these 12 months,
also with some notable fluctuations.
Stock market values-as measured by the Standard and Poor's 500
Composite Index-rose 13 percent in 2010, following a 23 percent gain
in 2009. Despite the back-to-back gains, the index at year's end was
still 20 percent below its October 9, 2007, peak. Corporate profits
rose rapidly in 2009 and 2010, and the gains in the stock market
have not kept up with the gains in earnings. As a consequence, the
price-to-earnings ratio for the S&P 500 had fallen by year's end to
about 17, slightly below the average of the 50 years through 2007.
Indicators of financial stress improved dramatically during 2009
and changed little during the 12 months of 2010. the spread between
the 3-month interbank lending rates and 3-month treasury bill rates
was only 16 basis points (or 0.16 percentage point) by December,
considerably below its 2000ï¿½07 average of 45 basis points.
Similarly the spread between AA- and B-rated corporate bonds had
fallen to only 3.6 percentage points, somewhat below its 2000-2007
average of 4.1 percentage points. Also during 2010, banks eased
standards on commercial and industrial loans.
Yields on 10-year treasury notes in December 2010 were 3.29
percent, down from 3.59 percent in December 2009. ten-year yields
rose early in the year but fell more than a full percentage point
from April to October, likely reflecting slow economic growth and a
flight to quality triggered by concerns abroad. Falling inflation
expectations may also have been a factor in the mid-year decline,
as suggested by the premium paid for treasury Inflation-Protected
Securities (TIPS). During the last two months of 2010, long-term
rates reversed part of their earlier decline. Despite the uptick at
year's end, yields on 10-year treasury notes were still at the low
end of their historical range. Real rates (that is, after
subtracting inflation expectations) were also low, as indicated by
the TIPS market where rates around the 10- year horizon were about
1 percent.
When the Administration's economic forecast was finalized in
mid-November 2010, the projected path for 91-day treasury bills
over the next two years was calibrated from rates in the market for
federal funds futures, which suggested that rates would remain
extremely low in 2011 and then edge up slightly in 2012.

[


THE LONG-TERM OUTLOOK
Looking ahead, the Administration projects moderate GDP growth of
3.1 percent in 2011, with growth then rising to an average rate of
4.1 percent during the next four years. table 2-1 reports the
Administration's forecast used in preparing the President's fiscal
year 2012 Budget. (the long lead time for the budget process
necessitates completing the forecast by mid-November, which was
before the year-end agreement on the tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of 2010.) the
Administration estimates that potential GDP growth-the rate of growth
of real GDP that could be sustained with the economy at full
employment and steady inflation-will be roughly 2.5 percent a year
(table 2-2, line 8). During 2011, projected GDP growth is slightly
stronger than potential growth, and the unemployment rate is
projected to tick down. Monthly payroll employment is expected to
increase each year in 2011,2012, and 2013. In the Administration
forecast, real GDP grows faster than its potential rate through
2017, gradually closing the gap between the actual and the potential
level of GDP.
The growth rate of the economy over the long run is determined by
the growth rate of its supply-side components, which include
population, labor force participation, the ratio of nonfarm business
employment to household employment, the workweek, labor productivity,
and the ratio of real GDP to nonfarm business output. The
Administration's forecast for the contribution of the growth rates
of these supply-side factors to potential real GDP growth is shown in
table 2-2. together, the sum of all of these components equals the
growth rate of potential real GDP, which is projected at 2.5 percent
a year.

[

CONCLUSION
The U.S. economy today has substantial excess capacity and therefore
vast potential to grow without igniting an increase in inflation.
the overall trend of economic data toward the end of 2010 has been
encouraging. the Administration's efforts to continue tax cuts for
the middle class, extend unemployment insurance, and provide
incentives for business investment strengthen prospects for
continued recovery in 2011.