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America’s Lost Decade?

Glen Hodgson, Senior Vice-President and Chief Economist, Forecasting and Analysis
June 27, 2011

In a recent article that appeared in The Washington Post and the Financial Times, former U.S. Treasury Secretary and Harvard University president Larry Summers speculated that the U.S. is in the midst of a “lost decade.” If accurate, what can be done to restore sustainable U.S. economic growth and job creation? And why is this important for Canada?

The U.S. economic performance is not entirely dismal, but it isn’t rosy. After the 2008 financial crisis and resulting recession, economic growth returned in mid-2009. The U.S. economy has since avoided a double-dip recession, although extraordinary monetary and fiscal stimulus gets most of the credit. Private sector job creation remains muted, and unemployment still exceeds 8 per cent. The housing market—a bellwether for the economy—is still in the dumps, due to ongoing foreclosures and weak consumer confidence. Annual housing starts are stuck at about 600,000, less than half the “normal” level. The Conference Board of Canada has downgraded its 2011 U.S. forecast. And although the U.S. economic outlook for the next few years is fairly solid, the risks to the medium-term forecast are much higher than normal.

The housing market—a bellwether for the economy—is still in the dumps.

If history provides any lesson, this subpar performance shouldn’t be a surprise. One of the most acclaimed recent economics books is This Time is Different: Eight Centuries of Financial Folly, by Carmen Reinhart and Kenneth Rogoff. It provides a detailed quantitative history and analysis of more than 200 financial crises globally since capitalism emerged in the mid-1700s. A key conclusion is once a financial crisis hits, it can take 5 to 10 years, or more before economic conditions return to “normal.”

Growth in gross domestic product can be restored fairly quickly after a financial crisis. But the economy often falls short of functioning at full capacity because consumer demand is weak due to fragile investor and consumer confidence. As the economy slowly rebalances, housing prices, financial market stability and credit conditions, job creation and related unemployment, and fiscal deficits can underperform for years.

That sounds a lot like the story unfolding for the U.S. today. It also sounds like the continuing story in Japan, two decades after its property bubble collapsed—and long before the tsunami of March 2011.

The financial system risks becoming hooked on low interest rates and easy money.

Can anything be done to accelerate the U.S. healing process? Larry Summers advised implementing measures to boost growth in domestic demand and placing less weight on measures to improve the supply or market conditions of the economy. In concrete terms, boosting domestic demand means a continuation of many of the policies already in place: that is, exceptional doses of monetary and fiscal stimulus.

But those measures come at a price. The level of U.S. public debt is rising quickly (the annual deficit exceeds US$1.3 trillion), and the financial system risks becoming hooked on low interest rates and easy money. Unpleasant as it sounds, the U.S. may just have to suffer through the adjustment period as it continues to adapt to the bursting of the property and financial bubble. Slower U.S. growth will mean sustained pressure on its fiscal accounts. It could also lead to a moderation of public expectations of America’s economic and social aspirations and its political and military leadership globally.

For Canada, this adds up to a chronically strong Canadian dollar, weaker exports to the U.S., and businesses having to innovate and adapt to stay competitive.

Glen Hodgson
Glen Hodgson
Senior Vice-President
and Chief Economist,
Forecasting and Analysis

Related Publications
U.S. Outlook: Spring 2011
World Outlook: Spring 2011