Growth Expected to Pick Up
The effects of the Great Recession have lasted for an exceptionally long period of time. For the past several years the level of output has remained below its potential level (the level that could be reached if all available capital and labor were being used at their full rate). Equivalently, the output gap (the gap between actual output and potential output) has remained wide open. The output gap is still 4 percent five years after the end of the recession. This is much longer than is typical—for instance, it was already less than 1 percent within three years after the end of the last two severe recessions (1973–1975 and 1981–1982).
In turn, the prolonged economic weakness has lowered the level of potential output by discouraging labor force participation and the number of potential hours that could be worked, by slowing the growth of labor skills and of human capital, by restraining the growth of investment and of physical capital, and by reducing R&D spending and total factor productivity growth. According to Congressional Budget Office (CBO) estimates, the Great Recession and the sluggish recovery will reduce the level of potential output in 2017 by 1.8 percentage points—0.7 percentage points from fewer potential labor hours, 0.6 percentage points from reduced capital services, and 0.5 percentage points from lower total factor productivity. Other studies estimate even larger effects. For instance, Ball forecasts that the Great Recession will reduce potential output in 2015 by 5.33 percentage points in the United States and by an average of 8.4 percentage points in 23 OECD countries; in some of these countries, the Great Recession depressed not only the level of potential output but also its growth rate.
The combination of prolonged economic weakness and slow potential growth has led to a debate on the risk that the economy may have entered or may soon enter a period of stagnation—a prolonged period characterized by low interest rates, low inflation rates, slow potential growth, and a level of output below potential. (Read a review of different views on the risk of secular stagnation.)
Current economic conditions, however, suggest that the economy continues to recover. In the five years following the end of the Great Recession, the economy grew at a steady, albeit modest, rate—real GDP grew at an average 2.2 percent annual rate. After declining at a 2.1 percent annual rate in the first quarter of 2014 due to temporary factors like bad weather, real GDP rebounded to a 4.2 percent annual growth rate in the second quarter [now revised to 4.6 percent as of 9/26/14], driven by household consumption and business investment. Reports on business conditions indicate that economic activity continues to expand. Growth is expected to pick up in the next few years and then to converge to a moderate rate in the longer run. According to the latest CBO forecast, real GDP will grow 1.5 percent this year, 3.4 percent both in 2015 and in 2016, 2.7 percent in 2017, and 2.2 percent on average between 2018 and 2022. Real GDP will grow faster than potential in the years 2015 through 2017, which will almost completely close the output gap by the beginning of 2018.