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Why the U.S. Recovery Is Lagging

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics and Director of the Maurice R. Greenberg Center for Geoeconomic Studies
June 3, 2011

Why the U.S. Recovery Is Lagging - why-the-us-recovery-is-lagging

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The latest jobs report from the U.S. Labor Department confirms the picture that emerges from CFR's economic tracking. Although the recession ended two years ago, the recovery is agonizingly slow. Friday's data show that nonfarm payrolls increased by only 54,000 in May, about one-third of what private forecasters expected and far fewer than the 232,000 jobs that were added in April. The unemployment rate ticked up from 9.0 percent to 9.1 percent.

CFR's quarterly chartbook*, which sets the U.S. recovery in historical perspective (PDF), shows that the economy has expanded by a total of 4.9 percent since the last recession officially ended in June 2009. By comparison, the average postwar recovery had generated an expansion of 9.4 percent by this stage in the cycle. Even taking into account the job creation of the past quarter, the total number of nonfarm jobs in the economy is only slightly above the number that existed before the recovery started. By contrast, the average postwar recovery had created some 2 million jobs by this stage.

Why has the recovery been so anemic? During the recession, real house prices declined more sharply than in any twentieth century contraction (see the historical comparison in a second chartbook [PDF]). But during the current recovery, house prices have failed to come back up; indeed, they have fallen a further 7.1 percent. This performance is worse than anything the United States has ever experienced in the post-war era.

Falling house prices have three consequences for the recovery. They increase mortgage defaults, damaging banks' balance sheets and so restricting lending to new business ventures. They reduce labor mobility, since a family with negative home equity may be reluctant to sell and realize the loss. Most importantly, falling house prices make families feel poorer, so dampening consumption. Another chart in our collection shows how households have continued to pay back debt since the start of the recovery. In every previous post-war cycle, the recovery has fueled rising consumer confidence and rates of consumption, boosting corporate profits and job growth.

The current economic cycle is outside the scope of historical experience in one further sense. In the average postwar recovery, the United States had a federal budget deficit of around 3 percent of GDP. This time, the United States began the recovery with a federal deficit that was fully three times larger, and it has barely shrunk since. The extraordinary scale of U.S. deficit spending is now reaching both political and financial limits: Politically, the Republicans in Congress are determined to cut federal spending; financially, ratings agencies are starting to signal that U.S. credit worthiness may lose its gold-plated status. If the rating agencies deliver on their warnings, the U.S. government's cost of borrowing may increase, pushing up the budget deficit and calling into question the U.S. dollar's reserve currency status. Following a similar move by Standard & Poors, Moody's Investors Services announced on Thursday that it might review the U.S. government for a possible downgrade.

Special factors may explain why the May jobs report was particularly awful. The Japanese earthquake disrupted global supply chains, hurting employment in manufacturing. The energy price spike drove families to cut back on discretionary spending, causing the leisure and hospitality sector to cut jobs after four months of solid expansion. But the larger truth is that the pressure to rein in government spending, coupled with continued pressure on household consumption from soft house prices, points to tough times ahead. The latest grim jobs report may not be the last.

* The chart book is produced by CFR's Maurice R. Greenberg Center for Geoeconomic Studies.

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