Where Is That GDP Growth We Keep Waiting For?

Balancing the budget through reduced spending and increased revenues, ending the vast expansion of the Federal Reserve's balance sheet and normalizing interest rates, are all necessary actions in the effort to right the economy in the face of the Great Recession.
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The U.S. economy is like a high hurdler racing down the track, expected to gain speed even as barriers impede progress.

Last week, we learned that the economy grew a paltry 0.2 percent in the first quarter of 2015, nearly recessionary. This news was greeted with surprise in the media and among pundits. The explanations varied widely, but most, as in the New York Times coverage, pointed to temporal factors like the weather or the recent decline in oil prices and the resulting slowdown in domestic oil exploration.

Those factors are undoubtedly important, but that analysis fails to understand that U.S. economic growth has been consistently weak since the end of the Great Recession in mid-2009. GDP growth since then has averaged two percent per annum, well below the economy's long-term growth rate of over three percent, and particularly weak in a post-recession recovery period. To put our current stagnant growth in perspective, the last time we had a full year of substantive negative economic growth in the United States was 1982; the economy grew at a rate of nearly eight percent in the following year. Total growth over the last four full years of recovery has been about that: eight percent.

So why? Is it the weather and the vagaries of ever changing oil prices, or is it something more fundamental? The cold January wind and February snows have little to do with why, for nearly a half decade now, our economy has been growing so slowly. The answer sits in the fundamental economic challenge facing policy makers. Congress, the White House and the Fed are trying to do something few other governments in the world have managed to accomplish: Maintain economic growth while rapidly unwinding the layers of stimulus that were required to keep the Great Recession from becoming an even deeper crisis.

The failure to understand and communicate that we are in the midst not of typical post-recession recovery, but of an economic normalization that is unique to our lifetimes, has yielded confusion and deep divisions in our country. Households ask: If the country is recovering, why are we not? Businesses ask: Why are they reporting year on year revenue declines, long after the recession has ended? And political leaders ask: Why is the economy unable to sustain growth of over two percent?

There were five core fiscal and monetary components in the battle against the economic crisis: The American Recovery and Reinvestment Act, expansion of budget deficits beyond the stimulus, including introducing and extending tax cuts and expanding spending on highly stimulative government programs like unemployment insurance, the Federal Reserve Bank's lowering of interest rates to near zero, and the Fed's Quantitative Easing. The actual or expected removal of each of these efforts has been a hurdle put in front of the economy, slowing its progress. Ending these policies and programs represents a vast multi-trillion dollar effort to normalize the U.S. economy.

The surprise in this era of normalization should not be that the economy has experienced low growth. The surprise should be that our policy makers have managed this normalization as well as they have. Our two percent GDP growth exceeds that of the EU and Japan, our closest economic peers, and the now multi-year string of 200,000 private sector jobs added every month is strong even in the best of times. A review of the scale of the actions taken gives a sense of the extent to which the resilience of the U.S. economy and any growth in GDP and jobs should be seen as a victory.

Here are the hurdles:

2012: The bulk of the spending from the $787 billion Recovery Act is completed.

2013: The largest tax increase in history is passed by Congress, among the new levies: The top rate for families earning over $400,000 rises 11.3 percent from 35 percent to 39.6 percent; the Payroll Tax returns to 6.2 percent from 4.2 percent, affecting all earners; and the ObamaCare 3.8 percent surtax on investment income on families earning above $250,000 kicks in.

Sequestration also passes Congress, and Federal discretionary spending begins its fall from nearly $1.4 trillion in 2012 to under $1.2 trillion.

2014: The impact of the tax increases and sequestration-required budget cuts drive down the Federal budget deficit to $483 billion, over $1 trillion below its peak of $1.5 trillion in 2009.

Late in the year, the Federal Reserve's Quantitative Easing, which flooded the market with demand for mortgage-backed securities, U.S. Treasuries and other forms of debt, ends with over $3.9 trillion in securities purchased and stored on the Fed's balance sheet.

2015: The Fed announces that it will begin to "normalize" interest rates at some point in the near future. The impact of announcing the intention is felt almost immediately, helping bring down the value of the U.S. dollar to 1.07 per euro from 1.35 just months earlier, driving up the cost of U.S. goods, whether jet engines sold in Europe or Manhattan apartments, by 25 percent for euro-denominated buyers; the dollar value of euro-denominated U.S. corporate earnings also suffer. The rate increases itself, when it happens this Fall or later, and will raise borrowing costs for everyone, from businesses building factories with bond financing to families buying a home with a mortgage or paying for lunch at Chipotle with a credit card.

The economy has hurdled these trillion-dollar barriers, and has others waiting ahead, but there is no villain here. Each of the policy decisions can be considered individually sensible. Balancing the budget through reduced spending and increased revenues, ending the vast expansion of the Federal Reserve's balance sheet and normalizing interest rates, are all necessary actions in the effort to right the economy in the face of the Great Recession. But it should come as no surprise then that, in the face of the end of those actions, the economy is growing at a slow pace and that, with the "normalization" of interest rates not yet digested, the economy may continue to grow at its sluggish pace for years to come.

We are in the middle of the second phase of the Great Recession, the Great Unwinding, in which the U.S. economy is trying to find its balance without supports. From the first glimmers of economic distress in late 2007 to the full restoration of "normalized" interest rates and reduction of the Fed's balance sheet, the economic crisis will likely span over a decade. Until then, the fact that the economy is growing at two percent should be considered a victory, and the businesses and families driving that growth as the government's role in the economy recedes to a sustainable level should be applauded.

The failure to define this period as part and parcel of the Great Recession, attributable to the eagerness to put it and its effects behind us, means that we are allowing ourselves as individuals, businesses and governments, to pursue these policies as if disconnected and be surprised by their outcomes. If we understand this period not as a typical post-recession environment but as a unique transition period required by the scale of the interventions needed to survive the Great Recession, how would policy be different and what might we do to soften the blow of this Great Unwinding?

We should keep in mind that even beyond the coming interest rate normalization will come yet one more hurdle for the economy to overcome, as the Fed may begin to unwind its bond portfolio by selling securities rather than just letting them mature. The sales will absorb demand for credit and may drive market interest rates higher. The impact of the Great Recession is still substantively with us, and will remain with us to the end of this decade.