Economic Outlook, January 2011

I am sure you are all familiar with the macroeconomic background to our current situation, even if you did not attend last year's luncheon. The 18-month long recession that ended in June 2009 was the most severe contraction since the Great Depression. In the five quarters that followed, real GDP grew at only a 2.9 percent annual rate, which is barely above trend and is quite modest when compared to other cyclical recoveries. Particularly frustrating was the soft patch that the economy entered last summer when GDP growth fell below 2 percent. But I believe we have emerged from that soft patch and have begun a phase of the recovery in which growth can be sustained at an above-trend rate. That should help us make more rapid progress on our pressing economic challenges. Let's take a closer look at our relatively sluggish economic performance in this recovery. But before we do, let me note that the views I express here are my own and do not necessarily reflect those of my colleagues on the Federal Open Market Committee (FOMC.)1 An obvious explanation is the sharp drop in housing construction. The preceding housing boom caused significant overbuilding in most regions, which resulted in a large number of vacant houses that were good substitutes for new construction. This overhang has dampened housing activity in many local markets and has kept new housing starts at about half the rate that would be needed to grow the housing stock at the same rate as population. Consequently, residential investment has failed to make a positive contribution to growth in this recovery. In contrast, consider the two most severe recessions of the past 60 years before the most recent episode – the recessions of 1973-75 and 1981-82. Residential investment rose at an average of 40 percent in the first year of recovery following those recessions.