September 30, 2013
|Alan Levenson, T. Rowe Price Chief Economist|
Five years after the collapse of Lehman Brothers led to the worst financial crisis since the Great Depression, the U.S. economy has proven resilient, but the recovery has been among the weakest in the postwar era. Alan Levenson, T. Rowe Price's chief economist, discusses this historic era with Steve Norwitz.
So Alan, what is your general assessment of the pace and the magnitude of this economic recovery since the financial crisis five years ago?
Well, you point out that if you just kind of overlay this recovery on all the post-World War II recoveries, it is very weak. But most of the literature I'm aware of says that when you've had a financial crisis, you're going to have a weaker recovery, and that compared to other financial crisis recoveries and how fast the economy has grown before, then it's not that disappointing.
The housing market bottomed in 2009 in terms of construction, but it didn't start to grow at all until 2010 and not steadily until 2011, so we've not had that leg. In the household sector, away from housing, usually in a recession you accumulate pent-up demand.
The saving rate was already so low we've been rebuilding savings, so we haven't had that push. The state and local government usually starts to expand spending coming out of a recession, but partly because of mounting pension obligations, but also because of the spree of borrowing and programs in the 2000s that state and local governments have until last year were a drag on growth, and the business sector looks at that. They don't need to hire as many people because there's less demand and that feeds into the slower consumer picture. And they don't need to invest it as fast in terms of planned equipment.
So other than that, the economy has been great.
OK. Now, the Great Recession destroyed something like 8 million jobs, and although the unemployment rate has fallen steadily since then, it remains relatively high and there's something like 1.9 million fewer jobs now than there were in 2008 before the financial crisis.
Why the sluggish growth in employment throughout this recovery?
Well, largely because of the sluggish growth in demand. The state and local sector just started adding jobs, or it really is more accurate to say the state and local sector stopped losing jobs late last year, earlier this year, is kind of poking its nose into positive territory.
And, you know, those are never going to come back. They've permanently downsized. It's going to be very slow. The construction sector, obviously, and housing-related sectors [are] permanently smaller, and, even though they overshot to the downside, [they] are adding slowly.
Manufacturing—we lost a lot of jobs, and those are going to come back slowly because it's going to take time to reap the benefits of improved competitiveness and also because productivity tends to be stronger in manufacturing.
But in general, it's just the demand for goods and services is weak, and so the demand for labor has been fairly weak.
Now corporations have racked up record profits. We've seen the financial markets fully recover the lost ground from the financial crisis, but five years ago, there was real concern that the financial system itself could collapse.
And is the financial system today fully recovered, or do you think there is still some risks that pose some threats?
My one word answer will be yes. It's fully recovered. Or substantially so in the sense that financial institutions are massively less leveraged than they were in 2008, better capitalized, have written off a lot of bad assets, and so are healthier right now in the context of a good economy.
We've not addressed the too big to fail issues fully, to my knowledge, but I don't see the asset class on banks' books at this point that have turned sour quickly, and it shows them not to be adequately capitalized.
So the markets are now a little nervous about the economy—the economy's ability to stand on its own without this massive Fed stimulus in terms of billions of dollars of asset purchases every month, and the Fed has said it's going to begin tapering these asset purchases.
Do you share that concern? Should the Fed be pulling back at this point?
Yes. And again, just by their own logic that they started doing these asset purchases to get improvement in the labor market, and they said they're going to keep doing them in some magnitude until they get substantial improvement in the labor market, but that to recognize incremental improvement you can take your foot off the gas a little bit.
Interest rates—policy rates are ridiculously low. Then when they start raising interest rates, it may be a couple of years before they get anywhere close to a neutral rate. So that says it's like four years until the underlying stance of monetary policy is a threat to the economy.
So the economy has reached a point where it's stable enough that it can withstand a gradual withdrawal of stimulus by the Federal Reserve?
Yeah. Again, we've got very low levels of activity, so there's not much cutting to do even if things started to weaken. But the other thing is the Fed is cutting from such low rates. Things are still very stimulative, and the credit markets are still conducive to growth.
So how would you describe the state of the U.S. economy today compared, say, with where we were back in 2008 as we were headed for a financial crisis that hardly anyone anticipated?
In much better balance because the reason a crisis like that occurs is because of accumulated imbalances—too much debt, too easy lending standards, too much leverage in the financial system, building too many houses—and everybody's overextended.
We're now getting up to a reasonable pace where we're not overextended in any of these ways. But we've not normalized the credit markets and that's one thing that's limiting the pace on housing recovery, for example.
So finally, how do you see the economy evolving from here? Is the pace of growth and hiring likely to accelerate to more normal levels over the next year or two?
Let's say pick up instead of accelerate because accelerate sounds too sudden and vibrant. But yes, we're growing at about 2% now. I'm with the consensus thinking we can do 3% next year, maybe three and a half the year after.
Two things have to happen. The first thing that happens is that the drag from the government sector is going to dissipate. The other thing that I'm expecting to happen and that needs to happen is that business fixed investment plant and equipment needs to grow faster. Over the last four quarters, it's been less than 2.5%.
But we're going to have to get used to an economy that if we get 3.5% growth, that's smoking, where we thought that was our right in earlier periods. Productivity growth is going to be lower and so is labor force growth. We just don't have the same potential.
Well, Alan, thanks very much for your reflections on the recovery from the financial crisis and the state of the economy.
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