Meeting America’s Growth Challenge

BERKELEY – The United States continues to recover from its deepest economic slump since the Great Depression, but the pace of recovery remains frustratingly slow. There are several reasons to anticipate modest improvement in 2013, although, as usual, there are downside risks.

Prolonged recession or a financial crisis in Europe and slower growth in emerging markets are the main external sources of potential danger. At home, political infighting underlies the two greatest risks: failure to reach a deal to raise the debt ceiling and an additional round of fiscal contraction that stymies economic growth.

Since 2010, tepid average annual GDP growth of 2.1% has meant weak job creation. In both this recovery and the previous two, the rebound in employment growth has been weaker and later than the rebound in GDP growth. But the loss of jobs in the most recent recession was more than twice as large as in previous recessions, so a slow recovery has meant a much higher unemployment rate for a much longer period.

Weak aggregate demand is the primary culprit for subdued GDP and employment growth. The 2008 recession was triggered by a financial crisis that erupted after the collapse of a credit-fueled asset bubble decimated the housing market. Private-sector demand contracts sharply and recovers only slowly after such crises. The private-sector financial balance swung from a deficit of 3.7% of GDP in 2006, at the height of the boom, to a surplus of about 6.8% of GDP in 2010 and about 5% today. This represents the sharpest contraction and weakest recovery in private-sector demand since the end of World War II.