Chart Book: Tracking the Post-Great Recession Economy
March 27, 2020
When President Trump took office in January 2017, he inherited an economy in its 91st month of economic expansion following the end of the Great Recession in June 2009. That expansion has continued into 2020, but a sharp contraction in economic activity from COVID-19 would likely end it.
While the expansion has been long, both the economy’s average annual growth rate and the typical workers’ earnings gains have been relatively modest by the standards of earlier long expansions. The President has claimed that his policies would produce a substantial and sustained increase in economic growth, and his Council of Economic Advisers has claimed that those policies would boost wages and employment substantially. By contrast, the Congressional Budget Office (CBO) and many other non-partisan analysts project much slower economic growth and increases in most workers’ earnings.
This chart book tracks the current economic expansion and the evolution of the economy under President Trump, both in terms of how it compares with other expansions over the past several decades and how it compares with his claims of what his policies will accomplish. This chart book supplants its predecessor, “The Legacy of the Great Recession,” which covers the decade from the start of the recession in December 2007 through December 2017 with a focus on the plunge into and recovery from the Great Recession.
Part I: Recovery and Expansion After the Great Recession
Longest Economic Expansion on Record Endangered by COVID-19
Through February 2020, the U.S. economy had grown for 128 months without any significant decline in economic activity that would mark the beginning of a recession under the criteria used by the National Bureau of Economic Research, the recognized arbiter of business-cycle dating. The current expansion is now the longest on record in NBER dating, which goes back to the 1850s.
(The NBER does not rely on a single economic indicator to date the start and end of expansions and recessions; rather it examines and compares the behavior of several different measures of broad economic activity. Because the NBER needs to establish that there has been a significant decline in economic activity “spread across the economy, lasting more than a few months,” its dating of the start of a recession doesn’t occur until well after the fact. For example, the NBER’s determination that the Great Recession began in December 2007 was announced on December 1, 2008. It’s likely that the decline in economic activity due to COVID-19 will be such that the NBER ultimately decides that March 2020 marks the end of the expansion and beginning of a recession.)
The Economy Began Growing in Mid-2009
After contracting sharply in the Great Recession, the economy began growing in mid-2009, following enactment of the financial stabilization bill (TARP) and the American Recovery and Reinvestment Act. Economic growth has averaged 2.3 percent per year since then. The pattern of quarterly growth has been uneven, with the expansion including several quarters with growth well above 3.5 percent but also two where it was negative.
Although growth faltered in 2015, it began gathering momentum again in mid-2016. Most recently, however, real (inflation-adjusted) gross domestic product (GDP) rose at a 2.1 percent annual rate in the fourth quarter of 2019 and was 2.3 percent higher than in the same quarter a year earlier.
A key question is what annual growth rate will be sustainable over time. Most analysts think that the 2017 tax cuts and additional program funding Congress enacted in early 2018 boosted GDP only temporarily. Before COVID-19, the Trump Administration projected that that growth would continue at about 3 percent in coming years; CBO, in contrast, projected that growth would fall back to under 2 percent over the longer term, as we discuss below in Part III.
Before COVID-19 Nonfarm Employment Increased Each Month for 113 Straight Months
Through February 2020, total (private and government) payroll employment had risen every month for 113 straight months. Private employment had risen for 120 straight months, but total government employment was barely above what it was at the start of the expansion.
Total nonfarm employment rose by 273,000 jobs in February. Private employment rose by 228,000; federal government employment rose by 8,000; state employment rose by 18,000; and local employment rose by 19,000.
Payroll employment growth has averaged 201,000 jobs a month over the past 12 months and 243,000 jobs a month over the past three months. This pace is still well above the 100,000 or fewer jobs a month required to keep up with potential labor force growth — the job growth necessary to keep up with working-age population growth when there’s no “slack” (underutilized labor or capital) in the economy.
The changes in tax policy and federal spending enacted at the end of 2017 and in early 2018 contributed to strong monthly job growth into this year, but CBO projected even before COVID-19 that the rate of job growth would fall to well under 100,000 jobs a month in coming years, consistent with its projection of only modest growth in the population of potential workers over the longer term.
Job Growth in 2009-2020 Expansion Better Than in 2001-2007
Nonfarm payroll employment fell more sharply in the Great Recession than in other recent recessions. In contrast to the rapid bounce-back in employment at the start of the 1980s expansion, the turnaround in the labor market trailed the revival of economic activity marking the beginning of the three most recent expansions.
The jobs deficit at the start of the 2009-2020 expansion was much larger than those at the start of the previous two expansions, and it took a long time simply to get back to the level of payroll employment at the start of the recession. That said, payroll employment growth was somewhat better than in the 2001-2007 expansion, and it went on much longer.
Nonfarm payroll employment was 10.2 percent (14.2 million jobs) higher in February than it was at the start of the recession.
The rise in payroll employment over its pre-recession peak was almost entirely due to private-sector job gains. Government employment was 399,000 jobs (1.8 percent) higher in February 2020 than it was in December 2007, accounting for only 2.8 percent of the total job gains since then.
In contrast, government employment in the three expansions preceding the Great Recession accounted for 13 percent (1982-90), 10 percent (1991-2001), and 25 percent (2001-2007) of each expansion’s employment gains over the level of employment at the peak of the previous expansion. In each case, state and local government job growth was the major contributor.
High Unemployment Lingered After Great Recession But Fell Below Rates Reached in 1990s Expansion
The relatively modest pace of job growth in the first years of this expansion (compared with the size of the job losses in the recession) kept unemployment quite high for some time after economic activity picked up. This initial persistence of high unemployment is similar to but more extreme than what happened at the start of the two previous expansions. The pattern in all three, however, is quite different from the sharp decline in unemployment at the start of most earlier expansions, including the expansion following the severe 1981-82 recession.
Nevertheless, by late 2015 the unemployment rate had fallen to 5 percent, its rate at the start of the recession, and it began to fall further at the beginning of 2017. The unemployment rate has been 4 percent or lower for the last 24 months. It has been in the 3.5 percent to 3.7 percent range since April 2019 and was 3.5 percent in February. Rates this low were last seen in 1969.
Growth in Workers’ Earnings Stopped Rising in 2019 Despite Low Unemployment
Average hourly earnings of employees on private payrolls grew modestly through much of the recovery, and to date, growth has averaged 2.4 percent annually. Inflation has been modest as well, but over much of the recovery, real (inflation-adjusted) wages failed to keep up with increases in workers' productivity, as we discuss below in Part III.
The pace of wage growth (before adjusting for inflation) quickened in 2015 and into 2016 but subsequently stalled below 3 percent until 2018, when it began edging up again. The upward trend in earnings growth for all employees stalled in 2019, however, despite very low unemployment. In February 2020, average hourly earnings of all employees on private payrolls were 3.0 percent higher than a year earlier; earnings of non-management employees were up 3.3 percent. Low inflation led to solid real wage gains in 2015 and 2016 and to lesser degree again recently, but stronger nominal wage growth is needed to achieve such gains with higher inflation.
Part II: Achieving and Maintaining Full Employment
As the 2009 Recovery Act’s temporary fiscal stimulus measures expired, the primary responsibility for nurturing the economic recovery fell to the Federal Reserve. The Fed has a “dual mandate” from Congress to pursue stable prices and “maximum employment.” It does so primarily by cutting interest rates to stimulate economic activity in a weak economy and raising interest rates to restrain economic activity in an overheating economy.
Since the early 1980s, the Fed has used changes in its target for the federal funds rate, the interest rate banks charge each other for overnight loans, to influence economic activity. Changes in the federal funds rate, in turn, induce changes in mortgage interest rates, other consumer interest rates, and the cost of business investment. In the Great Recession the Fed introduced additional unconventional tools to stimulate the economy once it lowered its federal funds-rate target essentially to zero and had no further room to cut it, and it did so again in March in response to COVID-19.
By conventional measures, prior to the COVID-19 pandemic, the economy has been close to the Fed’s maximum employment goal for some time. As of February 2020, the unemployment rate and some other measures of labor market slack (that is, excess unemployment and underemployment) were below their levels at the peak of the last expansion. The unemployment rate, for example, fell below CBO’s estimate of the “natural” rate of unemployment (the rate expected to prevail when the economy is operating at its full sustainable productive capacity). Yet inflation and wage growth were not signaling an overheating economy.
This situation gave the Fed an opportunity to probe how low the unemployment rate could go without generating unacceptable inflation, but such probing carries the risk that inflation might indeed begin to rise fast enough that the Fed would have to act more aggressively to cool an overheating economy. The short-term demand stimulus from the late-2017 tax cuts and early 2018 spending increases injected additional aggregate demand that complicated the Fed’s task in 2018.
Nevertheless, letting the economy run as “hot” as possible without triggering unacceptable inflation has many advantages, including reducing long-term unemployment, drawing people back into the labor force who want to work but are no longer actively looking, and reducing racial disparities in unemployment. So long as businesses and households believe that the Fed will act to rein in unacceptable inflation if it appears, the costs of prematurely cutting off the possibility of further employment gains should deter the Fed from tightening monetary policy too much or too fast. That belief also has gave the Fed leeway to cut interest rates when the expansion showed signs of faltering.
Fed Seldom Met Its Inflation Target in the 2009-2020 Expansion and Lowered Its Projection of Longer-Term Unemployment
The Fed in January 2012 formally adopted a 2 percent inflation target as its goal for price stability, and it recently has made it explicit that this is a symmetric target, not a ceiling, meaning that temporary deviations either below or above 2 percent will not necessarily elicit an immediate policy response. In practice, inflation was below the Fed’s target for most of the expansion, leading many analysts to believe the Fed was implicitly treating its inflation target as a ceiling.
The Fed does not have a specific target for its maximum employment goal. It does, however, periodically publish projections by the members of its monetary-policymaking committee of what they expect the unemployment rate to be in the longer run under their policies. As unemployment has fallen below those projections while inflation remained below target, the committee members have revised down their long-term unemployment rate projections. The current median projection is 4.1 percent, although actual unemployment was 3.5 percent in February, and prior to COVID-19, members’ median projection was that the annual rate would be 3.5 percent in 2020 before turning up.
The Fed began to lower its target for the federal funds rate in 2008 as the economy began to weaken, and it continued to cut rates as the financial crisis worsened and unemployment rose, until the federal funds rate was effectively zero by the end of 2008. To continue to provide needed monetary stimulus when it was up against this “zero lower bound,” the Fed adopted additional unconventional measures such as the purchase of longer-term assets — a policy known as quantitative easing — to try to lower longer-term interest rates and stimulate interest-sensitive spending more directly.
Judging that labor market healing was proceeding apace, the Fed took its first step to raise its target for the federal funds rate in December 2015, and it made a series of quarter-percentage-point increases thereafter that raised the range to 2.25 to 2.50 percent in December 2018. It also began a slow process of reducing its holdings of longer-term assets acquired during the period of quantitative easing, a process that ended in August 2019. Sensing the expansion might be losing momentum, the Fed cut its target range a quarter point to 2.00 to 2.25 percent in July 2019 and made two more quarter point cuts in September and October that lowered the range to 1.50 to 1.75 percent. In response to “evolving risks to economic activity” posed by COVID-19, the Fed cut its target range to 1.00 to 1.25 percent on March 3; it took the final step of cutting to 0 to 0.25 percent and adopting additional unconventional measures on March 15 in response to the effects on economic activity of COVID-19 and policy measures taken to contain it.
After Record-Setting Rise, Broadest Measure of Slack Employment Fell Below Rate at Start of Recession
The Labor Department's most comprehensive alternative unemployment rate measure — which includes people classified as “marginally attached” to the labor force, who want to work but have not looked for a job recently enough to be classified as unemployed, and people working part time because they can't find full-time jobs — recorded its highest reading on record in November 2009 in data that go back to 1994. This measure, known as U-6, fell steadily beginning in011 and was below 8.8 percent — its rate at the start of the recession — since February 2017. It edged up to 7.0 percent in February 2020, but the only time before recently that it was 7 percent or lower was in late 2000 in data that go back to 1994.
Prime Working-Age Population Recouped More of Great Recession Job Losses Than Overall Population Aged 16 and Older Did
The sharp rise in unemployment and discouragement over the prospects of finding a job in the Great Recession caused the labor force participation rate (the percentage of the population either working or actively looking for work) to fall sharply. The combination of rising unemployment and falling labor force participation produced a historically steep decline in the percentage of the population with a job (the employment-to-population ratio) for both the prime working-age population (those aged 25-54) and for the entire population aged 16 and older.
The employment-to-population ratio of those aged 16 and older remained near its recession low until 2014, when it began to rise as labor force participation leveled off while unemployment continued to fall. Nevertheless, in February 2020 it was still 1.6 percentage points below its rate at the start of the recession.
That population includes an increasing number of baby boomers near retirement or already retired. Thus, some of the difference between their employment rate at the start of the recession and its rate more than a decade later reflects demographic trends rather than labor market weakness. In contrast, the employment-to-population ratio for those in their prime working years (age 25-54), which fell 4.9 percentage points between the start of the recession and December 2009, recovered all of that loss and was 80.5 percent in February 2020. Nevertheless, it remained below the peak rates achieved in the 1990s expansion.
Black Unemployment Rate Fell to Historic Low But Remains Much Higher Than White Rate
Black or African American unemployment is persistently higher — roughly twice as high on average over time — than white unemployment. The difference between the two rates narrows when the economy is particularly strong and widens in recessions. Across data that go back to 1972, however, black unemployment in the best of times is not much better than white unemployment in the worst of times.
Black unemployment averaged 6.1 percent last year and was 5.8 percent in February 2020 after reaching an historic low of 5.4 percent in August 2019. The white unemployment rate, however, averaged 3.3 percent last year and was 3.1 percent in February. Moreover, the historical record strongly suggests that black unemployment will rise much more than white unemployment in the next recession.
Hispanic/Latino Unemployment Rate Near Historic Low
The unemployment rate for Hispanic/Latino workers lies between the black and white unemployment rates in recessions and expansions. It averaged 4.3 percent last year, touched an all-time low of 3.9 percent in September 2019 in data that go back to 1973, and was 4.4 percent in February 2020 — over a percentage point higher than the white unemployment rate. Like the black rate, it is likely to rise more than the white rate in the next recession.
Long-Term Unemployment Down from Record Peak But Long-Term Unemployed as a Share of All Unemployed Remains High
Long-term unemployment — the state of looking for work for 27 weeks or longer — reached much higher levels and persisted much longer in the Great Recession and lingering jobs slump in the early stages of the expansion than in any previous period in data back to the late 1940s. The worst previous episode was in the early 1980s, when long-term unemployment as a share of all unemployed workers peaked at 26.0 percent and the long-term unemployment rate peaked at 2.6 percent.
In the earlier episode, however, a year after peaking at 2.6 percent, the long-term unemployment rate had dropped to 1.4 percent. It took six years to fall back to that rate in the recent expansion, which it did in June 2015. That rate has since edged down and was 0.7 percent in February 2020. Still, nearly a fifth (19.2 percent) of the 5.8 million people who were unemployed — 1.1 million people — had been looking for work for 27 weeks or longer.
Prior to Coronavirus Pandemic, Unemployed Workers per Job Opening Fell Substantially and Workers Willing to Quit Their Jobs Rose
The number of people looking for work swelled in the Great Recession while the number of job openings shrank. At the beginning of the expansion there were nearly 7 people looking for work for every job opening. That ratio has declined substantially since, to the point where in January 2020 there were 5.9 million unemployed workers and 7.0 million job openings (about 85 job seekers for every 100 job openings).
Whether workers are happy or unhappy in their current job, they are far less willing to quit to look for another one when job prospects are poor than when they are good. The percentage of workers quitting their jobs fell sharply in the Great Recession, but rose in the expansion, surpassing the rate at the start of the recession. It remained, however, below the rate at the peak of the 1990s expansion.
Measures taken in the pandemic likely will severely distort these data.
Part III: Prospects for Economic Growth and Earnings
The Great Recession Caused a Sharp Drop in GDP and Lower Projections of Future Growth
For a half century prior to the Great Recession, actual GDP, which is determined by the demand for goods and services, fluctuated in a relatively narrow range around CBO’s estimate of what the economy was capable of supplying on a sustainable non-inflationary basis (potential GDP). Actual GDP fell below potential in recessions and temporarily rose above it in booms. The Great Recession created an unusually large and long-lasting gap between actual and potential GDP. That “output gap” generated substantial excess unemployment and underemployment and idle productive capacity among businesses.
The GDP gap narrowed, albeit slowly, over the next several years and closed in 2018, according to CBO’s January Budget and Economic Outlook: 2019-2029. Part of this gap-closing reflected growth in actual GDP as the economy recovered from the recession. A significant part, however, resulted from CBO’s successive downward revisions since 2007 to its projections of potential GDP. As a result, CBO’s estimates of both the level and growth rate of potential GDP for 2007-2017 are now much lower than projections made before the Great Recession. (The chart below is constructed so that a straight line represents a constant growth rate, with a steeper slope representing a higher growth rate.)
CBO projects that actual GDP will exceed potential this year but will slow thereafter. CBO does not try to forecast business-cycle fluctuations, but instead assumes that eventually real GDP growth will reflect underlying trends in potential GDP, and, while growing at the same rate, the level of actual GDP will be 0.5 percentage points lower than that of potential GDP, which is the average historical gap between the two.
President Trump’s Growth Goals Have Historical Precedents But Are Highly Optimistic for Today’s Economy
Growth in potential GDP, and hence the limit on sustainable growth in actual GDP, is determined by how fast the potential labor force and labor productivity grow. The potential labor force, in turn, grows through native population growth and immigration, while labor productivity grows through business investment in physical capital (machines, factories, offices, and stores) as well as investments in R&D and other intellectual property. Improvements in labor quality through education and training can also boost productivity, as can improvements in managerial efficiency or technology that enable businesses to produce more with the same amount of labor and capital.
Short-term changes in monetary and fiscal (tax and spending) policies aim to minimize bouts of excessive inflation or unemployment due to fluctuations in aggregate demand around potential GDP. “Supply-side” policies, such as well-conceived tax, regulatory, and public investment measures, can complement labor force growth and private investment in expanding potential GDP. They can also produce public benefits that GDP does not necessarily capture, such as distributional fairness and health and safety improvements. Poorly conceived policies, however, can impede growth and hurt national economic welfare.
The Trump Administration argues that its policies will return the economy to growth rates of 3 percent or more like those achieved in the second half of the last century. CBO’s more sober assessment reflects the importance of demographic factors like the retirement of the baby boom generation that, without greater immigration, will slow population and potential labor force growth substantially. CBO also projects that, while potential productivity growth will improve somewhat relative to its recent past, it will not match the 3.1 percent average rate achieved over the entire 1950-2018 period — which included 4.0 percent average annual productivity growth in 1950-73. CBO is not infallible, but its projections are more like those of other mainstream analyses than the Trump Administration’s are.
Growth in Purchasing Power of Workers’ Wages and Benefits Has Not Kept Pace With Productivity Growth
Productivity growth is the key to a rising standard of living. Employers can afford to pay workers more without threatening their bottom line when their workers produce more per hour worked and when businesses can charge higher prices for the goods and services they sell. Workers enjoy a rising material standard of living when their earnings rise faster than the cost of the goods and services they buy.
From 1948 to 1973, productivity and the real (inflation-adjusted) average hourly compensation (wages and salaries plus fringe benefits) of workers in the nonfarm business sector each nearly doubled, irrespective of whether inflation is measured using producer prices or consumer prices. From the mid-1970s to the mid-1990s, however, productivity growth slowed. At the same time, compensation per hour adjusted for inflation in consumer prices grew much more slowly than productivity, while compensation adjusted for inflation in producer prices grew at roughly the same rate as productivity.
That disparity arose because nonfarm business output includes not just consumer goods and services but also investment goods and exports, and those output components’ prices rose more slowly than consumer prices. Because compensation adjusted for producer prices tracked productivity fairly closely during this period, profit margins and hence the split in total income between the share going to workers and the share going to business owners and shareholders did not change much during this period. But because consumer prices rose more than producer prices, growth in the purchasing power of workers’ earnings fell short of growth in labor productivity.
Productivity picked up considerably in the decade of the late 1990s and early 2000s but was disappointingly slow in the recent expansion. Workers saw a brief spurt in their real compensation in the second half of the 1990s but have seen little progress since. Productivity has grown faster than compensation adjusted for producer prices since the turn of the century, indicating that producers have been able to increase their profit margins, raising capital’s share of nonfarm business income at the expense of labor’s share.
Over the course of the expansion, output per hour has risen at an average rate of 1.2 percent per year, compensation per hour adjusted for consumer prices has risen 0.6 percent per year, and compensation per hour adjusted for producer prices has risen 0.9 percent per year. Compared with a year earlier, output per hour in the fourth quarter of 2019 was 1.8 percent higher, compensation per hour adjusted for consumer prices was 1.5 percent higher, and compensation per hour adjusted for producer prices was 2.2 percent higher.
(CBO’s data on potential productivity growth discussed above cover the entire economy, including general government output and the output of households and some nonprofits, for all of which output is measured in a way that assumes no productivity growth. The data discussed here are for actual productivity growth in the nonfarm business sector, which covers about 75 percent of economic activity but makes a disproportionate contribution to measured productivity growth.)
|Average Annual Growth in Output per Hour and Real Compensation per Hour (Percent)|
|2009:Q2 - 2019:Q4||2018:Q4 - 2019:Q4|
|Output per hour||1.2%||1.8%|
|Real compensation per hour (consumer prices)||0.6%||1.5%|
|Real compensation per hour (producer prices)||0.9%||2.2%|
Part IV: International Trade, Federal Budget Deficits, and Growth
The United States buys more goods from the rest of the world than they buy from us, as President Trump emphasizes. However, the trade deficit in goods does not reflect the full scope of the United States’ balance of payments with the rest of the world, and contrary to the President’s rhetoric, a trade deficit does not make the United States “losers” in international trade or justify a trade war.
President Trump’s view of trade as a situation in which one country can only gain at the expense of other countries is at odds with the vast majority of economists’ broadly accepted understanding that trade makes each trading partner richer than it would be on its own. Trade expands the amount, quality, and variety of goods and services a country’s residents can buy by allowing the country to expand production of goods and services for export that it can profitably trade for other goods and services that are cheaper to import than to produce domestically. Economists find that trade wars, in which countries impose tariffs or other restrictions on imports from one another and/or subsidize their own exports, shrink those opportunities and make countries that engage in them worse off than they would be with more open trade.
While international trade can increase the overall size of the economy and provide net benefits to the country as a whole, it also creates winners and losers within the country, with the larger gains from trade spread broadly but thinly and the smaller losses concentrated in particular industries, regions, or groups of workers. The United States needs better policies to cushion the blow for those most affected by economic shocks of all kinds, including trade shocks, and to ease the inevitable transition to new patterns of economic activity in a dynamic, growing economy. It is also important for the United States to be a party to negotiating multilateral international trade agreements that set the rules under which countries trade with one another and settle international trade disputes in order for both the United States and its trading partners to enjoy the mutual benefits from trade, while avoiding costly trade wars.
Contrary to President Trump’s claims, a trade deficit is neither a sign of economic weakness nor under a President’s control. While trade policy can affect the composition of U.S. imports and exports and the trade balance with individual countries, the overall size of the trade deficit is determined by a complex set of relationships among broader forces, such as how fast the United States is growing relative to its trading partners, households’ and domestic businesses’ saving and investment decisions, multinational corporations’ decisions about where to invest (which are influenced by tax policy as well as economic fundamentals), and finally, federal budget policy and foreign central banks’ and international investors’ willingness to hold U.S. debt.
When U.S. households, businesses, and governments collectively spend more than they produce, excess spending must be met through net imports, and foreigners must be willing to finance that excess spending. Incomes, interest rates, and the foreign exchange value of the dollar adjust to bring the amount of excess spending, the trade balance, and foreign willingness to lend to the United States into alignment.
Trade Surpluses in Services and Net Payments From Foreigners Partly Offset Goods Deficit; Annual Net Borrowing From Foreigners Down From Mid-2000s Peak
The United States sold $1.7 trillion worth of goods to the rest of the world in 2018 and bought $2.6 trillion worth of goods from the rest of the world, resulting in a goods deficit equal to 4.4 percent of GDP. The United States ran a surplus in services (such as tourism, education, and financial services) and received more investment income and other payments from abroad than it sent abroad. As a result, the current account — the most comprehensive measure of trade and income flows between the United States and the rest of the world because it includes goods, services, and income earned in or paid to the rest of the world — had a deficit equal to 2.5 percent of GDP.
The United States’ balance of payments with the rest of the world, however, includes not only the income flows recorded in the current account but also capital flows associated with borrowing, lending, and investment by the United States and its trading partners. Dollars flow in when the rest of the world lends to the United States by buying U.S. Treasury securities and other U.S. financial assets or invests directly in the United States by acquiring, establishing, or expanding businesses here. Dollars flow out when the United States lends to the rest of the world by buying foreign financial assets or when U.S. companies invest abroad.
The United States is both the world’s largest direct investor in other countries and the largest recipient of foreign direct investment from the rest of the world. The difference between new foreign direct investment in the United States and new U.S. direct investment abroad is relatively small in most years. The United States is a large net borrower from the rest of the world, however, due to sales of U.S. Treasury debt and other financial assets to the rest of the world that far exceed U.S. purchases of foreign financial assets.
The dollars that flow out to purchase imports must ultimately flow back in as export sales or as an increase in foreign holdings of U.S. assets net of U.S holdings of foreign assets. In other words, net national borrowing is the mirror image of the current account deficit in the year those capital flows occur. Subsequently, the interest and profits that foreigners receive by lending to or investing in the United States will be income payments to the rest of the world in future current accounts, and the income the United States receives from foreign direct investment or purchases of foreign financial assets will be income payments from the rest of the world.
The United States has been a net borrower for much of the past four decades, with borrowing peaking at 5.8 percent of GDP in 2006. U.S. net borrowing and its complement, the current account deficit, then shrank with the collapse of trade and capital flows worldwide in the financial crisis and Great Recession and, while still large, have remained roughly the same share of GDP since 2009.
As a result of decades of net borrowing, the difference between total U.S. assets held abroad and total foreign assets held in the United States, known as the United States’ net international investment position, was a negative $9.6 trillion at the end of 2018. Nevertheless, the rest of the world so far has been a willing lender to the United States.
Moreover, despite this large net debt, the income the United States receives from its holdings of foreign assets has exceeded the income it pays to foreign holders of U.S. Treasury debt and other U.S. assets. Historically, the United States has enjoyed relatively low borrowing costs due in part to the dollar’s role as a “reserve currency” that is in demand worldwide to facilitate international trade and settle international financial obligations whether or not they involve the United States. Since the financial crisis, worldwide demand for safe financial assets, especially U.S. Treasury securities, has kept U.S. international borrowing costs particularly low relative to the income the United States earns on its investment abroad.
Federal Budget Deficits Are Often (But Not Always) the Major Source of Net National Borrowing
The United States has been a net international borrower every year but one since 1983. That’s because in most of those years federal budget deficits were larger than net lending in the rest of the economy. Unless policymakers reverse the large revenue losses from the 2017 tax cuts and raise enough revenue to meet 21st century budget needs, budget deficits will keep the United States a substantial net borrower over the coming decade and erode the country’s net investment income surplus.
Net lending or borrowing in a particular sector of the economy is the difference between that sector’s aggregate saving and its aggregate investment in productive capital. Any surplus of saving over investment is available for lending; any shortfall of saving relative to investment requires borrowing. An economy-wide surplus of saving over investment must be lent or invested abroad; a shortfall must be offset by borrowing or attracting investment from the rest of the world.
In the early to mid-1980s, a steep recession and policymakers’ decisions to lower tax rates and increase defense spending produced large federal budget deficits. Non-federal saving consistently exceeded non-federal investment, but by less than federal borrowing, hence the country was a net borrower in the international economy. (Non-federal lending or saving is the sum of such activity by households, domestic businesses, and state and local governments.)
In the 1990s expansion, by contrast, a strong economy together with effective deficit-reduction and budget-enforcement policies produced declining budget deficits and eventually surpluses in 1998-2001. Meanwhile, foreign funding attracted by the strong economy and booming stock market flowed in to help fuel a surge in domestic investment that outstripped domestic saving. These foreign capital inflows turned the non-federal sector into a large enough net borrower to keep the country as a whole a net borrower, despite the falling federal budget deficits and eventual surpluses.
The 2001 recession and deficit-producing tax cuts in 2001 and 2003 ended the brief era of federal budget surpluses. The federal government became a major borrower again, but businesses and households also went on a borrowing binge in the housing boom preceding the Great Recession. That combination led to record net national borrowing that reached 5.8 percent of GDP in 2006.
The Great Recession and policymakers’ enactment of temporary fiscal stimulus measures created large budget deficits in 2009-12. However, the substantial rise in federal borrowing to fund these deficits was partly offset by a collapse in investment and sharp reduction in borrowing in the non-federal sector, which turned it into a net lender again. As a result, net national borrowing, while still substantial, actually was lower as a share of GDP over this period than it had been immediately prior to the recession.
President Trump inherited a growing economy, but one with a large budget deficit that was projected to gradually get larger as a share of GDP over the next decade under the tax and spending policies in place at the time. He and Congress then made those projected future budget deficits even larger by enacting tax cuts and spending increases in late 2017 and early 2018 — well before the emergency measures being taken to address COVID-19
An increase in federal borrowing must be accommodated by some combination of higher private saving, lower domestic investment, and increased foreign borrowing. Any reduction in domestic investment means lower productivity, less future output, and lower workers’ earnings. Increased foreign borrowing can attenuate a decline in domestic investment due to federal budget deficits but interest and profits from investment funded by foreign borrowing will go to those countries rather than contribute to U.S. national income.
In a 2018 analysis, CBO projected a rise in the current account deficit to 3.6 percent of GDP in 2021, driven primarily by growing federal budget deficits, followed by a gradual decline to 3.0 percent of GDP by 2028 despite continued high federal borrowing, primarily as a result of slowing domestic investment relative to saving that raises non-federal net lending. CBO also estimated that the 2017 tax act would reduce U.S. net international income by an average of 0.3 percent of GDP over 2018-2028.
Part V: Conclusion
The economy was on solid footing when President Trump took office in January 2017. The economy had been growing since mid-2009 and the huge job losses from the 2007-2009 Great Recession had been erased by 2014. The economic expansion continued through 2019, becoming the longest expansion on record before the coronavirus pandemic sharply curtailed economic activity.
The President made bold claims for how his policies would raise the economy’s sustainable growth rate significantly above the 2.2 percent growth rate it had achieved prior to his inauguration and produce a significant increase in the typical worker’s earnings. Those claims are much more optimistic than what the Congressional Budget Office and most other outside analysts expect.
While the recovery appeared to be faltering in 2015, it regained momentum in the second half of 2016 and economic growth trended upward, with GDP 3.2 percent higher in the second quarter of 2018 than it was in the same quarter a year earlier. The growth rate has trended down since then, however, and GDP grew just 2.3 percent between the fourth quarter of 2018 and the fourth quarter of 2019. In contrast to the Trump Administration’s 3-percent growth claims, the most recent data are more in line with most analysts’ view that the growth spurt in 2018-2019 was temporary and fueled by demand stimulus from the tax cuts and spending increases enacted in late 2017 and early 2018 and that growth will revert to rates closer to a 2 percent rate, based on slow growth in the potential labor force absent substantial immigration and continued modest increases in labor productivity — the two constraints on the economy’s sustainable long-term growth rate. To date, ordinary workers have not seen the large wage gains the Trump Administration has promised.
It is too early for definitive judgements about whether the Trump Administration or its critics will be right about the economic effects of pre-COVID-19 economic policies and, of course, those judgments will be heavily influenced by the effects of the pandemic and the policies enacted to fight it. Certainly, the short-run demand stimulus from the tax cuts in an economy that was already close to full employment complicated the Fed’s efforts to achieve its dual-mandate goals of high employment and stable prices. In the longer run, the larger budget deficits associated with the tax cuts will undermine any “supply-side” effects of the tax cuts in stimulating greater work, saving, and investment.
Even before COVID-19, those larger budget deficits also would have likely increased the current account deficit, further weaken the United States’ net international investment position, and erode the surplus of net investment income in the balance of payments.