Listening to the Congressional Budget Office's Douglas Elmendorf this morning, I recalled the old Lyndon Johnson desire for a one-armed economist. On the one hand, Elmendorf forecast "a good deal more pain to come." On the other hand, he gave three reasons we can hope for better.
First, the pain. "There's still a good deal of pain to come," Elmendorf told reporters at a press breakfast sponsored by the Christian Science Monitor. He said that the Congressional Budget Office will release a new economic forecast in August but that he does not expect it to change greatly from January's report, which suggested that unemployment will not get down to the 5 percent neighborhood until 2018. "There's still a great deal of elevated unemployment to come," he said.
The historically high rate of long-term unemployment is especially alarming, he said, because of the lasting ripple effect it has on the economy.
The logic is basically that people that lose jobs stay out of work for a long time, have skills that deteriorate, they have connections to the job market that dwindle, and they find it harder, then, to re-enter employment and to re-enter in the sort of permanent jobs where they are very productive as they were before they lost their jobs. So we have built in to our projection elevated unemployment rate even at the end of the decade because of high levels of unemployment today … I think it's a very serious economic problem.
He also suggested that the great loss of household wealth during the Great Recession, quantified Monday in a report released by the Federal Reserve, is also a drag on the economy.
The loss of household wealth has been an important factor restraining spending. It's widely agreed among economists that household spending depends on the income that households have but also very importantly on how wealthy they feel. This report summed up something that many households know themselves and has been available in pieces of other data: the decline in stock prices, the decline in house prices over the last few years has been really dramatic.
He added: "I think it's quite possible that the amount of debt itself [held by households] has been weighing on household spending."
So are we just doomed then? Not necessarily. Elmendorf did offer three reasons why economic growth could outpace expectations.
First, he said, housing could do better than currently projected. There are roughly 500,000 starts expected in 2012, but "we and other analysts think that the level of housing starts needed to keep up with the underlying demographics of our country are about 1.5 million starts per year. So at the moment we have excess, unused houses, and we have a very restrained rate of household formation." As the economy starts to pick up and household formation increases, that could spur rapid growth.
A second possibility, Elmendorf said, is greater business activity.
Businesses are sitting on a lot of cash. They have not shown a great interest in using that, but why they haven't is not entirely clear. And business investment in fact is growing fairly strongly but from a depressed level—it fell very sharply during the downturn. So even though it's been growing rapidly in the last couple of years, it's still in the low level relative to the size of the economy, relative to the size of the capital stock, and businesses may decide they want to do more investment.
Finally, he said, experts may be underestimating the labor market.
The unemployment rate has fallen more sharply than we and most analysts have expected. Just why that's happening is also a bit of a puzzle. But it raises the possibility that there is more strength in the labor market than we expect … For many people it's a puzzle that this recovery's been as weak as it's been. And there are reasons for it but it's not at all impossible that more of the underlying strength of the economy will show itself in the next year or two.