The uneasy economy continued to dominate the headlines in 2010. Unemployment rates, climate change, the Federal Reserve and sovereign debt were among the top stories. Brookings experts Karen Dynan, Gary Burtless, Alice Rivlin, Henry Aaron, Donald Kohn, Douglas Elliott and Adele Morris weigh in on the year’s most compelling economic news and offer recommendations going forward.
With fiscal policy limited by our long-run federal debt challenges, monetary policymakers took action to address the lackluster economy in 2010. In early November, the Federal Reserve announced a plan to purchase $600 billion of longer-term Treasury securities by mid-2011. The plan has come to be known as “QE2” because it represents a second wave of the Fed’s so-called quantitative easing program, the first installment of which involved purchases of up to $1¾ trillion in longer-term assets during 2009 and early 2010.
QE2 was not a “big” economic event in the sense of being exotic. For some time, the Fed has not been able to increase monetary stimulus by lowering the short-term federal funds rate, its traditional policy lever, as that rate has been close to zero since late 2007. The next logical step has been to ease financial conditions by lowering still-positive longer-term interest rates; purchasing longer-term assets is simply a means to that end.
Nor was QE2 surprising. By law, the Federal Reserve has a mandate to set monetary policy so as to promote the dual goal of stable prices and maximum employment. With underlying inflation now well below the mandate-consistent target of 1½ to 2 percent and a gap between actual employment and full employment that is perhaps as large as 12 million, neither objective is currently being met. The Fed’s decision to implement QE2, a policy designed to both spur economic growth and return inflation to a more desirable long-run level, represented a step toward meeting its dual mandate.
What has been notable about QE2 is the considerable backlash that it has spurred. Critics abroad have argued that the U.S. is exporting its economic problems, as quantitative easing (like traditional Fed policy) puts downward pressure on the foreign exchange value of the dollar and and upward pressure on prices of foreign assets. This is a particular problem for emerging market economies that have rebounded faster than industrial economies and are now at risk of asset price bubbles and overheating more generally. Domestically, some skeptics worry that the weaker dollar and larger Fed balance sheet could put the U.S. economy at risk of excessive inflation.
These concerns merit serious discussion but reasonable counter-arguments can be made. On the international front, a more vigorous and sustainable U.S. recovery would have important benefits for the rest of the world. With regard to the domestic concerns, falling inflation (and its capacity to foster economic stagnation) has been a larger concern than rapidly rising inflation.
The backlash to QE2 bears watching because it lends support to those who wish to reduce Federal Reserve independence. While the Fed should be held accountable for its actions, excessive political oversight of monetary policy could prove very harmful to the U.S. economy. It would open the door to attempts to win over with voters by boosting growth and employment over the short run at the cost of higher inflation over the long run.
In 2010 the job market began to emerge from the most severe downturn since the Great Depression. U.S. employment is up, the layoff rate is down, and the average wage (after adjusting for inflation) has improved modestly. Progress toward full job market recovery has been achingly slow, however. The most striking feature of the past year has been the widening gap between the outlook for Americans who’ve held on to their jobs and their less fortunate peers who got laid off.
Hourly wages and the average work week have improved over the past year, boosting the pre-tax earnings of employees. Equally important for workers’ well-being, the chances of a layoff have declined. Since the end of last year, weekly new claims for unemployment insurance have fallen 12%. Employers say they are reducing the monthly number of layoffs. Between December 2009 and October 2010 the reported layoff rate fell almost a fifth. Since the peak of layoffs in late 2008 and early 2009, the layoff rate has dropped more than a third. Workers who worried at the beginning of 2010 about their chances of keeping their jobs could breathe a little easier by year’s end.
The improvement in employees’ economic outlook has fueled a modest rebound in consumption, which in turn has boosted employers’ need for workers. A sizeable fraction of this need has been met with temporary workers. Since December 2009 almost one-third of the net gain in U.S. payroll employment has been in the temporary help services industry. In addition, employers have added to the work week of employees who are already on their payrolls. The work week has increased a half hour since last December, or 1½%. Neither of these employer strategies helps laid off workers in their search for a permanent job.
The situation of the unemployed has not improved much over the past year. To be sure, the unemployment rate and the number of unemployed workers have edged down, but this is mainly because of the drop in the number of newly laid off workers each month. For workers who were jobless at the start of the year or who entered unemployment during the course of the year, chances of finding a job remain depressingly low. At the end of 2009, 40% of the unemployed had been without work for 6 months or longer. By November 2010, 42% of the unemployed had been jobless for at least 6 months. Unemployed workers can take consolation from the fact that this statistic is now heading in the right direction. Since late spring the average duration of on-going unemployment spells has dropped about 4%.
The prospects of the unemployed nonetheless remain bleak. In the years between 1945 and 2007, the number of jobless Americans with unemployment spells longer than 6 months never exceeded 26% of the total unemployed. In May 2010 the long-term unemployed represented 46% of the unemployed. Even though this percentage has fallen since May, it remains far higher than it was in the 1981-1982 recession, when the U.S. unemployment rate reached a post-war peak.
The basic problem facing job seekers is that employers are offering few job openings compared with the number of unemployed. The number of job openings has risen since the low point in early 2009, but job availability is not nearly high enough to put a major dent in unemployment. The Bureau of Labor Statistics (BLS) conducts a poll of employers every month to determine the number of job openings, new hires, and recent job separations. This survey offers the best gauge of U.S. job availability. Even with the recent improvement in job vacancies, the BLS survey shows that job openings are currently running almost one-sixth below the average rate over the 2000-2007 period. That 8-year period included a mild recession and a prolonged period of anemic job growth, so it should be clear that today’s vacancy rate is too low to generate rapid gains in payroll employment.
In a couple of respects, laid off workers were provided better protection in this recession compared with earlier ones. The most notable difference is that Congress funded up to 73 weeks of extended unemployment compensation after workers exhaust the 26 weeks of regular unemployment benefits. The total duration of benefits – up to 99 weeks in the states hardest hit by unemployment – is considerably longer than the maximum provided in past recessions (65 weeks). For workers laid off between September 2008 and May 2010 the federal government also offered to subsidize two-thirds of the cost of employer-sponsored health insurance premiums for workers covered by an employer health plan. In no previous recession did Congress provide laid off workers with this kind of subsidy. For many unemployed workers the subsidy is not generous enough. A large proportion of laid off workers cannot afford to pay a third of the cost of their insurance premiums. When they lose their jobs, they lose their health insurance, too.
In sum, 2010 was a year of only slight progress for the unemployed but real gains for workers who still have jobs. Without a surge in demand for goods and services produced in the United States, it is hard to see much improvement in the outlook for the unemployed. The pace of economic growth must increase before we can see a sizeable drop in unemployment. The growing gap between the fortunes of those with and without jobs is matched by the widening divide between Americans who work for others and the businesses that employ them. Measured in nominal dollars, corporate profits now exceed their pre-recession levels. Business profitability has returned, but total wage and salary disbursements remain lower than they were before the recession began. The political danger facing the unemployed is that surging business profitability and the improving fortunes of employees will cause voters to lose sight of the daunting problems confronting the long-term unemployed.
Historians of our era may describe 2010 as the year Americans finally woke up to the fact that their federal budget was on a dangerous course, hurtling toward a debt crisis that threatens American prosperity and international leadership. They may, but we won’t know until we see whether the political system responds with decisive action in 2011.
But once the election was history, the ultra-partisan rhetoric subsided and public discourse on fiscal matters shifted toward pragmatism. Two bipartisan commissions contributed to the more constructive tone by reporting compromise plans for bring deficits steadily under control and stabilizing the growth of debt. I was privileged to serve on both of them and the experience left me fairly optimistic that our political system can pull itself together and reach a bipartisan compromise in time to avert a debt catastrophe.
The National Commission on Fiscal Responsibility and Reform, ably led by Erskine Bowles and Alan Simpson, included a dozen high-ranking Senators and Representatives from both parties. (Brookings Trustee Ann Fudge and I were among the six public members). The Commission, appointed by President Obama, was charged with crafting a plan, to be released right after the election, for reducing the deficit to manageable proportions by 2015 and controlling future debt. The Commission with the support of a small staff spent months digging into the problem. Despite the fact that most of the members were busy campaigning, they came together in a constructive and collegial spirit to discuss a broad array of spending and tax options, including all the “third rail” political no-no’s that pundits declare untouchable. Until the election was over, no votes were taken. Indeed, nothing was written down for fear some leaked draft document would be misused on the campaign trail.
Shortly after the election the co-chairs produced a bold draft plan for the Commission to discuss. It included all the “third rails”-cuts in domestic and defense appropriations, curbing growth in Medicare, Medicaid, and Social Security benefits, drastic reform of the corporate and individual income taxes to simplify the structure and raise more revenue. Commission members, all of whom disagreed with some elements of the plan, welcomed it as a courageous effort to find middle ground without copping out on the assignment. After vigorous interaction with the co-chairs a somewhat altered plan was adopted by 60 percent of the members. Most of those not voting for it, nonetheless expressed their admiration for the effort and some offered their own alternatives. There were no “deficit deniers.”
Analysts disagree on whether the Affordable Care Act (ACA), signed into law by president Obama on March 23, 2010 should be regarded as a major economic event of 2010, the most important social legislation in decades, both, or neither. A good case can be made for each of these views.
The case for why the ACA was a major economic event is straightforward. Health care spending accounts for one-sixth of the U.S. economy. It has grown faster than income for half a century and is projected to continue indefinitely. Many billions of dollars each year go for procedures of little or no value, many of which cost far more to provide in the United States than they do in other countries. Projected increases in federal health care spending account for more than all of the anticipated increases in federal budget deficits. Thus, slowing the growth of spending and improving the efficiency of health care delivery is of enormous economic significance. The ACA sustains existing methods for slowing the growth of health care spending. It begins to implement virtually every major new idea for improving the efficiency of health care delivery and for slowing the growth of spending that analysts have proposed. To be sure, some of these ideas should have been pursued more aggressively than the ACA does. But the ACA is the law of the land. If implemented vigorously, it holds the promise of gradually slowing the growth of total and federal health care spending and reforming the way health care is delivered.
No one thinks that the spending slow down will come fast enough to avoid the need for tax increases or other reductions in government spending, but no other proposed strategy for controlling health care spending would do so either. No one thinks that the efficiency of health care delivery will improve rapidly. Thus, the ACA is just a first step-but an extremely significant one-in a long-term program to slow the growth of U.S. health care spending, something that is a necessary precondition for restoring long-term fiscal balance and an important component of a program to improve economic efficiency. That other steps will be necessary in no way diminishes the crucial role that the ACA can play.
The case for the ACA as landmark social legislation is equally strong. For nearly a century, presidents from both parties have sought to extend health insurance coverage to all Americans. The ACA takes a giant step toward achieving that goal. It promises to cut the proportion of Americans without health insurance by more than half. Every legal resident of the United States with income below the official poverty threshold would be insured either through Medicaid or private insurance. Those with incomes up to four times official poverty thresholds would be eligible for subsidies to hold the costs of health insurance below specified fractions of income. Everyone would be required to carry health insurance. Most businesses would be required to offer it to their employees as a largely-employer-financed fringe benefit. Limits would be placed on premiums that insurance companies could charge the elderly or those with preexisting conditions. They would be barred from cancelling insurance policies regardless of how much care the insured require. Given current budget deficits and the inescapable cost of extending insurance coverage-with attendant increases in use of health care services-the ACA went as far in extending coverage as current political and economic conditions would permit.
Of course, both of these claims for the ACA may be valid. There is no reason why the claims for the economic importance of the ACA should diminish its status as its status as social legislation. Paradoxically, however, both sets of claims may turn out to be if not false, then premature. The campaign to extend health insurance and reform the delivery of health care did not begin when president Obama announced his legislative program in 2009. Nor did it end with the signing ceremony on March 23, 2010 Rather, it will continue at least until 2013 and probably for many years after that.
Republicans fought vigorously to prevent passage of the ACA. They tried hard to persuade the American public that the bill was flawed. Public opinion polls indicate that they enjoyed considerable success. The ACA passed Congress without a single Republican vote. While Republican successes in the 2010 mid-term elections owed much to public dissatisfaction with the state of the U.S. economy, unease about health care reform also played a part. The Republican leadership has sworn to seek repeal of the ACA. That objective that is almost certainly out of reach as long as Democrats control the Senate and president Obama can veto any repeal legislation. But the ACA is likely to be a central issue in the 2012 elections. Should Republicans win the White House and a Senate majority, repeal may be possible. Meanwhile, the Republican leadership has pledged to stymie implementation. That goal may be achievable, as the House, which is now under Republican control, may be able to deny appropriations necessary to plan and carry out implementation.
Furthermore, even if funding is adequate, the administration and the states face extremely challenging obstacles in implementing the ACA. Success of the ACA hinges on the capacity of states to sign up 16 million new Medicaid enrollees and to assure that, once enrolled, they can find service providers. All fifty states need to set up health insurance exchanges to provide subsidies to millions of Americans. The federal government must design practical rules not only to guide the states in providing subsidies but also to enable the Internal Revenue Service to recapture over-payments made to people who turn out not to be eligible for them. This last challenge is particularly delicate, as subsidies will be paid to insurance companies on behalf of families and individuals deemed to be eligible based on current income, but overpayments must be collected from the families themselves based on their annual income.
For all of these reasons, the 2010 signing ceremony for the ACA, although indisputably a historic moment, was the just one event in a multi-year drama that began decades ago and will continue for many years. Future historians may hail the signing of the ACA as an epochal achievement in extending health insurance coverage, initiating measures to improve the efficiency of health care delivery, and creating reforms to slow the growth of health care spending. They may see it as yet another failed effort to enforce changes in a system virtually all observers see as flawed and seriously dysfunctional. Which of these two stories comes to be written will depend on events to be played out over the next few years.
As the crisis phase of financial and economic turmoil receded in the latter part of 2009 and 2010 (though for an exception to this see the Forum posting on sovereign debt problems), attention of global economic policymakers turned increasingly to global imbalances-large and persistent current account deficits and surpluses. Continuation of these imbalances was seen as posing challenges for economic recovery and for the stability of employment and activity once economies returned to full employment. With many advanced economies hobbled by continuing balance sheet problems, full global recovery will require a greater push from domestic demand in emerging market economies. And, although global imbalances earlier in the 2000s did not directly cause the economic crisis as many had feared, and banking crises can readily occur in countries running large surpluses as Japan demonstrated in the 1990s, imbalances contributed to the conditions that led to the financial crisis in the United States and other industrial economies. The capital flows arising from the surpluses in emerging market economies held down interest rates in advanced economies encouraging leveraging and rising house and other asset prices. And the borrowing corresponding to the U.S. current account deficit was reflected in unsustainable increases in the debt of the household and government sectors here. Gaps and lapses in regulation and supervision in the United States and Europe allowed the resulting leverage, lax lending practices, and maturity transformation to build to dangerous levels that proved all too vulnerable to a softening in house prices and onset of borrower repayment problems.
There is broad agreement that the recovery of the global economy cannot rest on the U.S. consumer or on demand by governments in industrial countries. Financial and economic stability require a higher level of domestic saving in the United States by households and governments than we had a few years ago, balanced by higher investment and net exports. The other side of that coin is that other economies cannot rely on exports to U.S. and other industrial countries as the main drivers of increases in production and employment. Instead more global demand must come from increased purchases by the residents of those economies currently in large surplus positions, especially where those surpluses reflect not economic fundamentals but rather artificial restraints on exchange rates or capital flows. Fundamental shifts in saving and spending patterns will be required for rebalancing; government policies to encourage private and public saving in the United States and other deficit countries and to boost spending in surplus countries will be critical elements in achieving a more sustainable configuration of trade flows. But relative prices will also have to change to make exports by the United States relatively less expensive on world markets and those from the surplus countries relatively more expensive; it will be far less painful and disruptive to do that through movements in exchange rates than through inflation in surplus countries and deflation in deficit countries. In that regard, greater exchange rate flexibility by China is a critical element in fostering a smooth transition to higher levels of production globally and a more sustainable pattern of trade.
The uneven pattern of recovery from the “Great Recession” is straining global relationships. The sluggish growth of the advanced economies, coupled with the imperative for fiscal consolidation in many places, means that interest rates there are very low and are likely to be extraordinarily depressed for some time to come. At the same time, many emerging market economies are growing strongly, are much closer to full employment, and are concerned about inflation and asset price bubbles arising from the inflows of capital from the advanced economies. More flexibility in exchange rates will help with these problems too because these economies would be better able to tighten monetary policies as suited to their individual circumstances and investors will be faced with more tow-way risk in exchange rates. Nonetheless, the surplus countries could still encounter difficulties maintaining economic and financial stability in the face of large capital inflows. Still, they should guard against putting into place the types of capital controls that will distort the global allocation of resources over time; deficit countries for their part must resist any protectionist pressures that may intensify as unemployment remains high.
The G-20 has made dealing with imbalances a high priority and has enlisted the IMF in a Mutual Assessment Process to help countries understand the spillover effects of their policies and devise consistent strategies to advance the goals of higher, more balanced, and more sustainable global output. To date, they have been unable to move beyond agreement on obvious generalities. In fact, the global financial system is not well constructed to apply adjustment pressure to surplus and deficit countries alike. The French, who lead the G-20 in 2011, have made achieving progress on imbalances and on reforming the system a high priority for next year.
2010 was the year the difficult challenge of putting government debts and deficits on a more sustainable path over the long-run came much more clearly into focus. In the United States we saw several bi-partisan efforts to lay out paths to fiscal sustainability. But nowhere did the issues become more pressing than in Europe, where the governments of several countries faced growing doubts about their ability to meet their obligations now or in the future. These doubts resulted in sharply higher spreads on their debt and questions about their continued access to markets, precipitating a crisis that required intervention by other countries of the European Union, the European Central Bank, and the IMF.
The reasons for the actual and expected large borrowing needs and associated severe market problems differed somewhat across countries, but they included: revenue shortfalls and spending increases associated with the deep recession, which in some cases came on top of fiscal shortfalls even in the preceding good times; the pledge of governments to stand behind the debt of home-country banks that have mammoth losses from the bursting of housing bubbles in several European countries; long-run issues related the demands of an aging population on the social safety net; and the erosion of competitive positions in several peripheral countries after they joined the European Monetary Union, which made them dependent on external capital inflows while depriving them of devaluation as a way to restore competitiveness.
Intervention by European and international authorities was sparked by fears of contagion if one country was forced to restructure its debt. Channels for contagion included the potential for spreading doubts about the value of the debt of other European countries with stressed fiscal positions, and the losses that would be absorbed by many European banks if the value of a significant amount of European sovereign debt needed to be marked down. The forms of intervention included liquidity help for European banks from the ECB, which continued to accept sovereign debt as collateral even after it had been downgraded by credit rating agencies; ECB purchases of sovereign debt in the open market; and the establishment of back up facilities by the European Union and the IMF to lend to countries that lost access to markets. These back up facilities were activated for Greece and Ireland. The quid pro quo for this help was sharp cut backs in government spending and increases in taxes by countries in need of assistance; other countries moved pre-emptively in the same direction to head off market problems. Fiscal austerity by troubled countries would reduce government borrowing needs and over time level out debt-to-GDP ratios, and it also could help to restore greater competitiveness through decreases in government wages and pensions, which could spill over to reduce costs in the private sector as well. But it also implied higher odds on very weak economic performance in the short- to medium-term while austerity was being phased in.
As the year drew to a close, how these developments would play out remained in doubt. Spreads on the debt of a number of European countries continued to be very wide. And political backlash was in evidence–against austerity and associated economic weakness in the troubled peripheral countries, and, in Germany, against providing taxpayer support for these countries. Moreover the path to substantially increased competitiveness and reduced reliance on external credit for many of the countries was far from clear. The European authorities were devising structures to impose greater and more consistent fiscal discipline within the European Union and to make the back up facility permanent, albeit with the loses shared by the future holders o