What a difference two months make. As recently as November, when Republicans scored strong gains in the US congressional elections, the universally accepted explanation was economic performance that was perceived as disappointingly weak. (As always, “it is the economy, stupid.”) A substantial share of the American public thought that economic conditions were actually deteriorating last year; many held President Barack Obama responsible and voted against the incumbent party.
Now suddenly everybody has discovered that the US economy is doing well after all. So much so that Republican leader Mitch McConnell, newly elevated to Senate Majority Leader, has switched from a position that the economy is bad and Obama is to blame, to a position that the economy is good and the Republicans should get the credit. On January 7, he suggested that recent good economic data could be attributable to “the expectation of a Republican congress.”
But (as many have now pointed out) the improvement in performance began well before the November election. The brightening also began well before September, the date when polls began to indicate that the opposition party was likely to do unusually well in the vote.
The fact is, job growth was vigorous throughout 2014, averaging 246,000 per month for a year total of three million. It was enough to bring the unemployment rate down to 5.6% in December 2014 (from 6.7 % in December 2013). This employment growth represented an acceleration relative to the 185 thousand monthly average of the last three years, 2011-2013. It looks even better compared to the preceding economic expansion of 2002-2007, when job creation averaged 102 thousand per month, let alone compared to the recession years 2001 or 2008-2009. It was even as good as the Clinton years!
Similarly, GDP growth began to pick up steam in the spring of 2014, running above the rate of the preceding three years. It even reached 4.8% in the 2nd and 3rd quarters together, though that is almost certainly temporary. Europe, in stark contrast, remains in the dumps. Partly as a result of income growth, the US budget deficit came in better than forecast last year: 2.8 %. This represents a record improvement relative to 2009, when the budget deficit registered almost 10 per cent of GDP.
Just yesterday, the mystery was why growth was so weak, averaging only 2.1 per cent during the years 2011-13. There were four kinds of explanations.
The first explanation was the Reinhart-Rogoff principle that recovery from a recession takes longer if the origin was a crash in housing and financial markets. But there is another principle that the deeper the initial recession, the more rapid the rate of growth per year in the recovery phase. The point about financial crashes being worse than other recessions is more a statement about the magnitude of the initial decline and the corresponding length of time subsequently necessary to get back to normal, than a prediction about the annual rate of growth during the recovery phase.
The second theory was that the slow recovery was part of a longer-term trend, attributable to secular stagnation or a dearth of new important technological innovations. It is true that productivity growth and labor force growth have slowed since 1975 and perhaps even since 2000. But it does not seem wise to explain away three years of weak recovery by means of downward revisions in estimates of the long-run trend in potential GDP.
The third interpretation is that the deep recession of 2008-09 had long-lasting effects via long-term unemployment and depressed investment, and hence on the capital stock and the size and skills of labor force.
The fourth explanation for slow growth during 2011-13, however, seems the simplest: dysfunctional fiscal politics. These years featured the “fiscal cliff,” debt-ceiling standoffs, flirtation with federal default, a government shutdown, and budget sequesters. One does not need to assume big Keynesian “multiplier effects” to conclude that the combined effects shaved at least one percentage point from growth each year – especially if one believes that the risk created by such unpredictable behavior discourages firms from hiring workers or undertaking investment. According to the Economic Policy Uncertainty Index, the debt ceiling crisis of 2011 and government shutdown of 2013 each spiked uncertainty to levels as high as had the terror attacks of 2001 or the Lehman failure of 2008.
Then why stronger performance over the past year? 2014 was the first year, since the Republicans achieved a majority in the House of Representatives in November 2010, that dysfunctional fiscal policy did not actively impede the economic recovery.
The government shutdown of October 2013 was perceived to have turned out politically damaging to Republicans, including by the Republican leadership themselves. Thus they determined to refrain from such dead-end show-downs in 2014, even though doing so meant over-ruling certain noisy “Tea Party” members. One could have predicted that a year in which Congress refrained from actively impeding economic growth would be a year when the pace of expansion in output and employment would pick up. If the new Congress in 2015 refrains from standoffs, sequesters and shutdowns, there is no reason why the economy cannot continue to do well in the new year.
Of course the US economy retains some shortcomings. Wage growth is still slow. Median household income has barely begun to recover and remains well below its level of 2000. The explanation is that most of the income gains have gone to people at the top of the income distribution. Indeed, of the various possible reasons why the electorate in 2014 did not perceive the economic recovery, the most natural is that the typical American had not shared in the gains. The irony is that rising inequality is usually thought to play to the Democrats’ electoral advantage.