NCPA - National Center for Policy Analysis

Is the U.S. Economy Freefalling?

September 9, 2011

An examination of the 15 worst financial crises in the second half of the 20th century show that economies persistently perform poorly after a financial crisis, with real gross domestic product (GDP) growth 1.5 percentage points slower in the decade after the crisis than in the one before.  In 10 of the 15 cases, the unemployment rate did not return to its pre-crisis low for the entire decade after the fall.  The United States is contending with an expected painful deleveraging cycle and excessive regulation that slows growth, but we may not have laid the foundation for sustained expansion.  Real per-capita output is still 2.2 percent off its 2006 level, and effective fiscal consolidation and true tax reform are unlikely to come out of Congress in the run-up to the 2012 elections.  Vincent R. Reinhart, a former director of the Federal Reserve Board's Division of Monetary Affairs and resident scholar at the American Enterprise Institute, would put the chance that the U.S. economy slips into another recession within a year at about 4 in 10.

Key points in Reinhart's study:

  • The United States is experiencing the expected aftershocks of a financial crisis: a painful deleveraging cycle, bad mortgage loans that continue to drag down economic growth and excessive regulation in the form of Dodd-Frank.
  • But contrary to expectations, the United States may not have laid the foundation for sustained expansion, with real per-capita output still 2.2 percent below its 2006 level; the chance that the economy slips into another recession within a year is about 4 in 10.
  • With multiple European governments on the brink of default and Washington divided squarely along partisan lines, successful fiscal policy will be hard to implement. The Federal Reserve should declare that it will keep policy accommodative as long as its forecast falls short of its objectives, thereby encouraging risk taking by investors.

The severity of the recent economic shock shows that quick and forceful action by regulators did not prevent the U.S. economy from placing in the lower tier of recoveries.  The best course of action is for the Federal Reserve to explain that it will keep policy accommodative as long as its forecast falls short of its objectives.  Accommodation should be read generously to include the Fed's balance sheet as well as its policy rate.  Purchases of Treasury securities could nudge investors toward accepting more risk and so encourage economic growth.

Source: Vincent R. Reinhart, "Is the U.S. Economy Freefalling?" American Enterprise Institute, August 2011.

For text:

http://www.aei.org/outlook/101073

 

Browse more articles on Economic Issues