The Economic Outlook: A Puzzle By Any Other Name

Economic Policy Division

Labor Market

1991199119911991199119911991199119911991199119911992199219921992199219921992199219921992199219921993199319931993199319931993199319931993199319931994199419941994199419941994199419941994199419941995199519951995199519951995199519951995199519951996199619961996199619961996199619961996199619961997199719971997199719971997199719971997199719971998199819981998199819981998199819981998199819981999199919991999199919991999199919991999199919992000200020002000200020002000200020002000200020002001200120012001200120012001200120012001200120012002200220022002200220022002200220022002200220022003200320032003200320032003200320032003200320032004200420042004200420042004200420042004200420042005200520052005200520052005200520052005200520052006200620062006200620062006200620062006200620062007200720072007200720072007200720072007200720072008200820082008200820082008200820082008200820082009200920092009200920092009200920092009200920092010201020102010201020102010201020102010201020102011201120112011201120112011201120112011201120112012201220122012201220122012201220122012201220122013100

110

120

130

140Million

1991199219931993199419941994199419951995199619961996199619971997199719971998199819981998199819981999199919991999200020002000200120012001200120012002200220022002200320032003200320032004200420042004200420042005200520052005200520062006200620062006200720072007200720072007200720072008200820082008200820082008200920092009200920092009200920092009200920092009200920092009200920092009201020102010201020102010201020102010201120112011201120112011201120112011201120112011201120112011201120112011201120112011201120112011201120112012201220122012201220122012201220122012201220122012201220122012201220132013201320132013201320132013201320132013201320132013201320132013201420142014201420142014201420142014201420142014200

300

400

500

600

700SA, Thousands, 4-week Moving Average

199119911991199119911991199119911991199119911991199219921992199219921992199219921992199219921992199319931993199319931993199319931993199319931993199419941994199419941994199419941994199419941994199519951995199519951995199519951995199519951995199619961996199619961996199619961996199619961996199719971997199719971997199719971997199719971997199819981998199819981998199819981998199819981998199919991999199919991999199919991999199919991999200020002000200020002000200020002000200020002000200120012001200120012001200120012001200120012001200220022002200220022002200220022002200220022002200320032003200320032003200320032003200320032003200420042004200420042004200420042004200420042004200520052005200520052005200520052005200520052005200620062006200620062006200620062006200620062006200720072007200720072007200720072007200720072007200820082008200820082008200820082008200820082008200920092009200920092009200920092009200920092009201020102010201020102010201020102010201020102010201120112011201120112011201120112011201120112011201220122012201220122012201220122012201220122012201320132013201320132013201320132013201320132013201420142014201420142014201420142468

1012141618

Unemployment Rate U-6

Percent

Total Nonfarm Jobs

Initial Unemployment

Claims

Unemployment Rate August

6.1%

1991199119911991199119911991199119911991199119911992199219921992199219921992199219921992199219921993199319931993199319931993199319931993199319931994199419941994199419941994199419941994199419941995199519951995199519951995199519951995199519951996199619961996199619961996199619961996199619961997199719971997199719971997199719971997199719971998199819981998199819981998199819981998199819981999199919991999199919991999199919991999199919992000200020002000200020002000200020002000200020002001200120012001200120012001200120012001200120012002200220022002200220022002200220022002200220022003200320032003200320032003200320032003200320032004200420042004200420042004200420042004200420042005200520052005200520052005200520052005200520052006200620062006200620062006200620062006200620062007200720072007200720072007200720072007200720072008200820082008200820082008200820082008200820082009200920092009200920092009200920092009200920092010201020102010201020102010201020102010201020102011201120112011201120112011201120112011201120112012201220122012201220122012201220122012201220122013100

110

120

130

140

150Million

Household Employment

Change in U.S. Output: Recoveries

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 200

5

10

15

20

25

30

198220012009

Quarters from the start of Recovery

Percent Change from Start of Recovery

Economic Recovery is Natural• Markets heal• Resources realign• Prices adjust• The output gap closes as the economy returns

to full employment

U.S. GDP Actual and Potential Quarterly, Q1 1980 to Q4 2015

Real GDP Trillion 2009 Dollars Log Scale

198019801980198019811981198119811982198219821982198319831983198319841984198419841985198519851985198619861986198619871987198719871988198819881988198919891989198919901990199019901991199119911991199219921992199219931993199319931994199419941994199519951995199519961996199619961997199719971997199819981998199819991999199919992000200020002000200120012001200120022002200220022003200320032003200420042004200420052005200520052006200620062006200720072007200720082008200820082009200920092009201020102010201020112011201120112012201220122012201320132013201320142014201420142015201520152015

Actual

Potential 48.0

Potential GDP estimated by Congressional Budget Office

$15.0

$9.0

$18.0

$12.5

$6.5

Forecast

Ingredients of a Rapid Recovery

• Entrepreneurial spirit

• Flexible financial and labor markets

• Benign policy environment

The Big Puzzle: Why the slow recovery?

The Big Puzzle: Why the slow recovery?

Answer: Lagging business investment

Next Puzzle: Why is business investment lagging?

Answer 1: Excess capacity

Why is business investment lagging?

Answer 1: Excess capacity

Real Answer: Washington

Why the Slow Recovery?Strike 1: Poor Policy Focus

Why the Slow Recovery?Strike 1: Poor Policy Focus

2009: Poorly designed stimulus Cap and trade legislation

Why the Slow Recovery?Strike 1: Poor Policy Focus

2009: Poorly designed stimulus Cap and trade legislation

2010: Obamacare

Why the Slow Recovery?Strike 1: Poor Policy Focus

2009: Poorly designed stimulus Cap and trade legislation

2010: Obamacare2012: Tax hikes

Why the Slow Recovery?Strike 1: Poor Policy Focus

2009: Poorly designed stimulus Cap and trade legislation

2010: Obamacare2012: Tax hikes2014: Income inequality and Inversions

Why the Slow Recovery?Strike 1: Poor Policy Focus –

and not just from President Obama….

• Republicans shut down the government• Some threatened to allow government to default

– Not exactly a business confidence booster

Why the Slow Recovery?Strike 1: Poor Policy Focus

Strike 2: Regulatory Policy

Why the Slow Recovery?Strike 1: Poor Policy Focus

Strike 2: Regulatory Policy

• In five years, 157 new major rules• 26 new major rules in 2013 alone• Cost of $73 billion annually

Why the Slow Recovery?Strike 1: Poor Policy Focus

Strike 2: Regulatory Policy

Strike 3: Policy Uncertainty

Sources of Policy Uncertainty• Dodd-Frank financial regulation• ACA regulations• Environmental regulations• Monetary policy

Why the Slow Recovery?Strike 1: Poor Policy Focus

Strike 2: Regulatory Policy

Strike 3: Policy Uncertainty

• Three strikes against a robust recovery

Economy set to accelerateGDP Growth Rates• 2011: 1.6 %• 2012: 2.3 %• 2013: 2.2 %

Forecast:• 2H 2014: 3.0 %• 2015: 3.1 %

Three Headwinds on the Horizon

Three Headwinds on the Horizon

1) The Fed’s Puzzle: tapering and exiting

Jan2008

Feb.

Mar.

Apr.

May

June

July

Aug.

Sep.

Oct.

Nov.

Dec

Jan2009

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan2010

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan2011

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan2012

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan2013

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan2014

Feb

Mar

Apr

May

Jun

Jul

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Excess Federal Reserve Assets Money Supply (M1)

Billions $Fed Policy

Bank Assets and Liabilities

CBO’s Inflation Forecast

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 20240.0

0.5

1.0

1.5

2.0

2.5Percent

Consumer Price Index

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 20200

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Excess Federal Reserve Assets

Billions $

Fed Policy

Bank Assets and Liabilities

Not a Forecast

Three Headwinds on the Horizon

1) The Fed’s Puzzle: tapering and exiting

Interest rates will rise as economy recovers

They may rise faster, farther, as the Fed exits

Three Headwinds on the Horizon

1) The Fed’s Puzzle: tapering and exiting2) The Fiscal Puzzle: Debt, deficits, and interest rates

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

-15

-10

-5

0

5 Percent of GDP

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

-2000

-1500

-1000

-500

0

500 Billions $

Deficit to GDP

CBO’s Baseline Deficit(August 2014)Budget Deficit

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

0102030405060708090

Percent of GDP

Government Baseline Outside Debt

(CBO’s Baseline – August 2014)

Debt to GDP

Debt

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2023

0

5,000

10,000

15,000

20,000

25,000Billions $

Three Headwinds on the Horizon

1) The Fed’s Puzzle: tapering and exiting2) The Fiscal Puzzle: Debt, deficits, and interest rates

Crowding out has not gone away

Interest rates will go higher as a result of this increase in debt

CBO’s Interest Rate Forecast

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 20240.0

1.0

2.0

3.0

4.0

5.0

6.0

10 Year Treasury Note

Percent

Building on CBO’s Interest Rate Forecast

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 20240.0

1.0

2.0

3.0

4.0

5.0

6.0

10 Year Treasury Note QE Reversal

Percent

Building on CBO’s Interest Rate Forecast

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 20240.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

10 Year Treasury Note QE Reversal

Debt & Entitlements

Percent

Three Headwinds on the Horizon1) The Fed’s Puzzle: tapering and exiting2) The Fiscal Puzzle: Debt, deficits, and interest rates

Crowding out has not gone awayInterest rates will go higher as a result of this increase in debt

And don’t forget the looming entitlements problem:

Three Headwinds on the Horizon

1) The Fed’s Puzzle: tapering and exiting2) The Fiscal Puzzle: Debt, deficits, and interest rates3) Many international puzzles:

Big worries: Europe, ChinaLesser worries: Ukraine, Middle East, Americas

Review the Bidding• Recovery has been very weak• Due largely to Washington policies• Headwinds may hold us back, but then

– Any reasons for optimism?

Any Reasons for Optimism?• Refilling the well for startups

Household Balance Sheet

19801980 - Q21980 - Q31980 - Q419811981 - Q21981 - Q31981 - Q419821982 - Q21982 - Q31982 - Q419831983 - Q21983 - Q31983 - Q419841984 - Q21984 - Q31984 - Q419851985 - Q21985 - Q31985 - Q419861986 - Q21986 - Q31986 - Q419871987 - Q21987 - Q31987 - Q419881988 - Q21988 - Q31988 - Q419891989 - Q21989 - Q31989 - Q419901990 - Q21990 - Q31990 - Q4199119911991199119921992199219921993199319931993199419941994199419951995199519951996199619961996199719971997199719981998199819981999199919991999200020002000200020012001200120012002200220022002200320032003200320042004200420042005200520052005200620062006200620072007200720072008200820082008200920092009200920102010201020102011201120112011201220122012201220132013201320132014102030405060708090Trillion $

Household Wealth

0

10

20

30

40

50

60

Nonfinancial Assets

Financial Assets

Trillion $Household Assets

Any Reasons for Optimism?• Refilling the well for startups• Recovering labor market flexibility

199819992000200120032004200520062008 20130

500

1000

1500

2000

2500Thous. of Units, SAAR

Housing Market Trends

Housing Starts

2000200020002000200020002000200020002000200020002001200120012001200120012001200120012001200120012002200220022002200220022002200220022002200220022003200320032003200320032003200320032003200320032004200420042004200420042004200420042004200420042005200520052005200520052005200520052005200520052006200620062006200620062006200620062006200620062007200720072007200720072007200720072007200720072008200820082008200820082008200820082008200820082009200920092009200920092009200920092009200920092010100

150

200

250

300Sales Price, Thous. $

Existing HomesNew Homes

Median Home Prices

20002000200020002000200020002000200020002000200020012001200120012001200120012001200120012001200120022002200220022002200220022002200220022002200220032003200320032003200320032003200320032003200320042004200420042004200420042004200420042004200420052005200520052005200520052005200520052005200520062006200620062006200620062006200620062006200620072007200720072007200720072007200720072007200720082008200820082008200820082008200820082008200820092009200920092009200920092009200920092009200920102010201020102010201020102010201020102010201020112011201120112011201120112011201120112011201120122012201220122012201220122012201220122012201220132013201320132013201320132013201320132013201320142014201420142014201420142500

3500

4500

5500

6500

7500

200

400

600

800

1000

1200

1400Thous. of Units, SAAR

Existing Home Sales (right axis)New Home Sales (left axis)

Home Sales

20002000200020002000200020002000200020002000200020012001200120012001200120012001200120012001200120022002200220022002200220022002200220022002200220032003200320032003200320032003200320032003200320042004200420042004200420042004200420042004200420052005200520052005200520052005200520052005200520062006200620062006200620062006200620062006200620072007200720072007200720072007200720072007200720082008200820082008200820082008200820082008200820092009200920092009200920092009200920092009200920102010201020102010201020102010201020102010201020112011201120112011201120112011201120112011201120122012201220122012201220122012201220122012201220132013201320132013201320132013201320132013201320142014201420142014201480

100120140160180200220 Housing

Affordability Index

Any Reasons for Optimism?• Refilling the well for startups• Recovering labor market flexibility• Rationalizing business structures

Review the Bidding• Lackluster recovery

– Due almost entirely to poor Washington policies

Review the Bidding• Lackluster recovery, about to accelerate

Review the Bidding• Lackluster recovery, about to accelerate • Three possible headwinds

– from Washington, especially higher interest rates • From the Fed• From federal debt and deficits

– from overseas

Review the Bidding• Lackluster recovery • More headwinds, but also • Three reasons for optimism

Refilling the startup wellRegaining flexibility in labor marketsImproving business structures

Review the Bidding• Lackluster recovery • Three headwinds vs three reasons for optimism

Outlook:• Steady growth, with a chance for better, especially

with better policies

Final Policy Puzzle: How can government help now?

Final Policy Puzzle: How can government help now?

1) Near Term: Get Out of the Way

Final Policy Puzzle: How can government help now?

1) Near Term: Get out of the way!2) Next year – do something positive

– Not this:

Final Policy Puzzle: How can government help now?

1) Near Term: Get out of the way!2) Next year – do something positive

– Immigration reform– Some tax reform– Reform one entitlement program– Pass a sustainable highway bill

Final Policy Puzzle:How can government help now?

3) And stay out of the way

A Puzzle By Any Other Name

Economic Policy Division