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.
The Fed’s QE2 — Unsurprising Move but Surprising Reaction
Karen Dynan, Vice President and Co-Director, Economic Studies
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.
A Growing Gap between the Outlook for the Employed and the Unemployed
Gary Burtless, Senior Fellow, Economic Studies
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.
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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.
Excerpt: The Return to Fiscal Sanity Began in 2010—Or Did It?
Alice Rivlin, Senior Fellow, Economic Studies
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.”
What Lies Ahead for the Affordable Care Act
Henry J. Aaron, Senior Fellow, Economic Studies
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 import