The US Economy Analysis

Introduction

Despite the domestic challenges that America has faced over the years, especially following economic recessions as witnessed in the past, its financial system remains the largest and most significant across the world. In fact, the economy represents about 20 percent of the total global output. In addition, according to IMF rankings, the US has the sixth largest per capita income in the world. The dominant drivers of this expansive economy encompass the technological, services, financial, retail, and the health sectors. Nonetheless, just like most other economies, the economic growth of the US has been marked by phases of expansion, recession, and recovery.

Currently, the economy is still recovering from an economic turmoil caused by the global recession of 2008. As revealed in this paper, a number of factors such as policy failure, excessive risk-taking by financial institutions, widespread lending by the mortgage industry, and high government debts have been linked to the 2008 economic recession. Fortunately, the formulation and implementation of macroeconomic policy solutions by the US Federal government have been instrumental in speeding up the recovery and restoration of the economy to its initial glory. In this regard, experts including the IMF, remain optimistic concerning the future economic prospects for both the US and consequentially the global economy.

The US GDP and the Primary Measure of its Growth

As shown in Graph 1 below, between 2001 and 2007, the US economy experienced a slow but steady expansion at an average GDP growth rate of 2.5 percent. Moreover, the GDP grew from 12.682 trillion dollars in 2001 to 14.874 trillion dollars in 2007. During this period, the US economy experienced a boom in the housing market, as well as equity shares, resulting in record highs in profits by corporate firms.

Chart Showing the US GDP Changes between 2001 and 2016.
Graph 1: Chart Showing the US GDP Changes between 2001 and 2016. Source: (Amadeo)

In 2008, as revealed in Graph 1 above, the US economy sank into a recession with far-reaching impacts on economic indicators such as GDP, Real GDP, and nominal GDP. Moreover, Chang et al. highlight that the depression also resulted in a downturn of the US banking sector, the stock market, and a rise in unemployment (1). For instance, the recession led to a reduction in the Gross Domestic Product from 14.874 trillion dollars in 2007 to 14.830 trillion dollars and 14.414 trillion dollars in 2008 and 2009 respectively.

The depression also resulted in a fall in the growth rate from 1.8 percent in 2007 to -0.3 percent and -2.3 percent in 2008 and 2009 respectively. However, after the recession period of 2008-2009, the US economy has been in a phase of expansion and recovery at a steady rate of 2.0 percent. Subsequently, the GDP has grown from 14.419 trillion dollars in 2009 to 16.662 trillion dollars in 2016. The rate of growth has also been relatively low when compared to previous expansion periods such as the one between 2001 and 2007. For instance, the 2.0 percent growth expansion since 2010 is lower compared to that of 2.7 percent that existed between 2001 and 2007.

Factors that Led to the US Recession

According to Bordo, policy failure was a major catalyst that contributed to the US economic recession of 2008 (107). Specifically, the Federal Housing Administration failed to regulate the mortgage industry in an effort to push for affordable housing for Americans. This situation was actualized following the reduction of capital requirements by government-sponsored enterprises (GSEs) and consequently encouraging lending by mortgage institutions. As a result, the GSEs increased their profits, a move that further encouraged them to take more risks.

Furthermore, the Bush administration urged the mortgage institutions to increase their lending to low-income households. According to Bordo, the lack of a clear regulatory policy by the Federal Housing Administration resulted in poor lending standards, thus paving the way for money borrowing with little regard of income, assets, job, or documentation (107). Bordo (121) also highlights that the Fed’s choice in the targeted lending rather than the market liquidity provision exposed it to the temptation of politicizing the selection of credit recipients, especially the low-income families.

Despite such policies increasing the accessibility of the targeted recipients to credit, it also increased the number of risky subprime mortgages. This situation eventually led to the collapse of the mortgage industry due to the witnessed increase in defaulters. Another policy failure by the Fed as mentioned by Bordo regards the bailing out of insolvent firms such as Bear Stearns and AIG (122). Such policy actions only served to increase the appetite for credit lending by mortgage institutions through hiding the risky nature of the borrowing.

Another factor that has been associated with the 2008 economic recession is excessive risk-taking by financial institutions. Furthermore, a number of elements have been regarded as incentives to excessive risk taking by financial institutions that existed before 2008. One of these elements is compensation. The unregulated compensation mechanisms that were adopted by financial institutions may have partly been responsible for excessive risk taking by these institutions through their encouragement of unduly risk ventures.

The beneficiaries of unregulated compensation and excessive risk taking include traders, investors, investment bankers, and lenders. In this regard, two types of compensation asymmetries emerged because of excessive risk taking. One of these asymmetries was the treatment of losses and gains. For instance, while losses were part of the result of risk-taking ventures by financial professionals, there lacked a comparable cap on gains. This state of affairs implied that their compensation would never exceed a certain low while the gains remained limitless.

Secondly, there existed an asymmetry or imbalance between the magnitude, term, and the probability of losses and gains. For example, bonus arrangements were issued to reward financial professionals for their short-term results, even though they were later reversed following the 2008 recession. Such systems only encouraged these professionals to take greater risks that would bring superior rewards while concealing the losses that would have resulted from taking such risks.

Reavis believes that widespread lending by the mortgage institutions triggered the eventful US financial recession of 2008 (3). Before the crisis, financial institutions were accustomed to issuing high-risk loans and mortgages to people without any regard for their ability to repay the loan. The reduction in credit scrutiny resulted in a short-term boom of the housing market and consequently growth in the US economy. This growth resulted in an increase in household debt to GDP ratio from 50 to 100 percent by the mid-2000s.

Since most of the recipients of subprime mortgages lacked the ability to pay back the loans, they began to default. By 2006, the mortgage industry had begun showing indications of a burst. More people were beginning to default, with the number of foreclosures also increasing. As a result, the market prices for housing were pushed down, thus leading to a cessation of the trading of subprime mortgages by Wall Street giants. Eventually, small mortgage companies were left with huge debts from banks, a situation that also made them default their loans, thus triggering a collapse of the financial sector since many banks were declared insolvent.

Macroeconomic Policy Solutions that Led to the Recovery and Current Expansion

One of the macroeconomic solutions that have been instrumental in the recovery and current expansion of the US economy is the development and implementation of the Economic Stimulus Payments Act (Broda and Parker 26). This policy was passed and signed into law in 2008 by the American legislative body in an effort to encourage household spending. The payments consisted of basic and conditional reimbursements. Basic payments entailed a maximum compensation of 300-600 dollars for couples that filed the case jointly and a tax liability of up to 600 to 1200 dollars for those who did it discretely. On the other hand, households were issued with a conditional payment as a supplemental compensation of 300 dollars per child if they were eligible for the tax child credit. Broda and Parker note that the program distributed about 100 billion dollars to households and as a result increased their spending on goods and services (26).

Fitoussi highlights government bailouts as a policy response aimed at rescuing government mortgage lenders such as Fannie Mae and Freddie Mac (114). The two entities are said to have owned 76 percent of the US mortgages, thus making them a significant player in the 2008 financial crisis. Therefore, their bailout through covering all their losses by the Federal government was instrumental in the recovery of the housing market. Likewise, the government has also been involved in bailing out large financial institutions such as AIG since the failure of these institutions caused a freeze in the US credit market. However, Erkens et al. argue that the massive bailouts of these institutions by the Federal government after the 2008 recession may have diminished the positive effect of raising capital through equity by firms, consequently negatively affecting the long-term performance of these firms (402).

To counter the failed monetary guidelines by the Federal Reserve, the Federal Open Market Committee (FOMC) formulated two unconventional monetary policy tools. The tools consisted of the quantitative easing programs and explicit forward guidance for future federal funds rate. The two unconventional policies would provide the necessary accommodation regarding the monetary policy that would aid in ending the recession while subsequently strengthening the recovery of the economy. Moreover, the policy actions were instrumental in putting down pressure on interest rates in the long term, resulting in an improvement in the nation’s overall financial condition, including boosting the corporate equity and residential property prices. In turn, favorable financial conditions also helped to bolster aggregate demand, including checking unwanted disinflationary influences, through the increased support for household spending, investment, net exports, and construction.

Taylor asserts that one of the causes of the 2008 depression in the United States was the poor implementation of the existing regulatory policy by the New York Fed for financial institutions (4). As a result, the New York Fed intentionally or inadvertently allowed the financial institutions to sway from the existing safety rules, hence allowing them to take excessive risks. Taylor also affirms, “The main problem was not insufficient regulations, but a failure to enforce existing regulations” (5). In this regard, there have been many changes in the regulatory policy for financial institutions.

Taylor mentions the Dodd-Frank Act as one of the policy changes that have positively influenced the US economic recovery and expansion (6). The policy suggested a merger of the Office of Thrift Supervision into the Controller of Currency Office. Additionally, the Act created hundreds of new regulatory rules aimed at increasing dogmatic interventions in the financial sector. Furthermore, other regulatory policies have also been advocated and implemented such as the 30 percent increase in the number of federal workers who were involved in regulatory activities between the years 2006 and 2012.

Future Economic Outlook for the US and the Global Economy

According to Davis et al., the global economy has experienced a low growth rate since the end of the 2008 financial crisis (6). Moreover, interest rates have remained low, despite the increase in debt levels. This situation has resulted in the poor performance of government bonds that continue to record negative yields. Regarding income, real wages remain low in spite of the 80 percent of the global economy at full employment. This state of affairs has led to an increase in the inequality gap in both developed and developing markets. Regardless of the aggressive policy efforts by national economies such as the US aimed at countering deflationary shocks and bolstering economic growth, world economic growth has stagnated at low rates.

In addition, the low growth and high inflation of the US and global economy may restrain future growth rates unless drastic economic measures are taken. Central banks across the world are also said to reach a critical stage of exceeding the stipulated limits of monetary policies, resulting in attenuated benefits and increased economic risks. Davis et al. argue that the current economic strategies by central banks such as negative interest rates do not respond sufficiently to the existing and future economic pressures such as the weak demand, low consumer spending, unemployment, and reduced investments (7). Nonetheless, Davis et al. suggest that the right course of action, for instance, by the US Federal Reserve, would be to deliberately raise short-term rates to 1.5 percent in 2017 while also reducing its long-term projections to a rate a 2.5 percent (8). Such level would be more consistent with the global growth, thus improving the overall outlook of the economy.

On a positive note, Davis et al. believe that the potential growth in the global economy is poised to pick up modestly as time goes by (8). This assertion is based on the existing prospective growth in productivity rates, thanks to supportive structural factors such as a better utilization of innovative digital technologies, globalization, and demographic changes (an aging population, baby boomers and a decline in dependency ratios) followed by the recovery of the labor market since more unemployed people will get jobs in the technological companies. Furthermore, the slowing down of growth in emerging markets, a reduced accumulation of the US Fed reserves, and the continued increase in the level of global debts can put pressure on interest rates. This situation may reduce the cost of technology, consequently stabilizing future inflation rates and yields.

Similarly, the IMF remains positive on growth prospects in the global economy, which is currently estimated at 3.0 percent. This figure is in line with forecasts made on October 2016. Moreover, the IMF forecasts an accelerated growth in both emerging and advanced economies in 2017 and 2018 at the projections of 3.4 and 3.6 percent respectively. Specifically, advanced economies such as the US are projected to grow at a rate of 1.9 and 2.0 percent for 2017 and 2018 respectively. Nonetheless, these projections remain uncertain in the light of the probable changes in policy frameworks by the United States following the transformation in administration.

Conclusion

The US economy has experienced growth changes from expansion and depression to recovery. For example, between 2001 and 2007, the economy experienced a period of steady expansion at a rate of 2.7 percent. This development preceded a period of depression that lasted almost two years (2008 and 2009). During the downturn, the country’s GDP growth rate sank to rates of -0.3 percent and -2.3 percent in 2008 and 2009 respectively.

Factors that have been implicated as the causes of the depression include poor policy formulation and implementation, a widespread lending by mortgage institutions, and the excessive risk-taking by financial institutions. To counter the depression and regain growth, the US Federal government has been involved in the implementation of macroeconomic solutions. In this regard, four policies have been formulated. They include fiscal policies, for instance, the Economic Stimulus Act, monetary policies such as FOMC quantitative easing programs, and the explicit forward guidance and regulatory policy solutions such as the Dodd-Frank Act. The policies have been pivotal in the US post-depression expansion and recovery.

Works Cited

Amadeo, Kimberley. “The Strange Ups and Downs of the U.S. Economy Since 1929.” The Balance.

Bordo, Michael. “The Federal Reserve’s Role: Actions Before, During, and After the 2008 Panic in the Historical Context of the Great Contraction.Economic Working Papers.

Broda, Christian, and Jonathan Parker. “The Economic Stimulus Payments of 2008 and the Aggregate Demand for Consumption.” Journal of Monetary Economics, vol. 68, no. 1, 2014, pp. 20-36.

Chang, Shu-Sen, et al. “Impact of 2008 Global Economic Crisis on Suicide: Time Trend Study in 54 Countries.” British Medical Journal, vol. 347, no. 1, 2013, pp. 1-15.

Davis, Joseph, et al. “Economic and Market Outlook: Stabilization, not Stagnation.” Vanguard Research, vol. 1, no. 1, 2017, pp. 1-39.

Erkens, David, et al. “Corporate Governance in the 2007–2008 Financial Crisis: Evidence From Financial Institutions Worldwide.” Journal of Corporate Finance, vol. 18, no. 2, 2012, pp. 389-411.

Fitoussi, Jean-Paul. After the Crisis. LUISS University Press, 2012.

Reavis, Cate. “The Global Financial Crisis of 2008: The Role of Greed, Fear, and Oligarchs.” MIT Sloan Management Review, vol. 16, no. 1, 2012, pp. 1-22.

Taylor, John. Causes of the Financial Crisis and the Slow Recovery: A 10-Year Perspective. Stanford University Press, 2013.