An Overview of the U.S. Economy from 2004 to 2007
Despite the economic turmoil that the country is embroiled in, the United States remains the largest and most technologically powerful economy in the world. The country has the highest level of output in the world, with gross domestic product (GDP) valued at US$13. 21 trillion in 2006. As one of the world’s most advanced economies, the country still leads the way in the information technology revolution and in many other areas of technical innovation. The U. S. economy is diverse, with leading industries including automobile, aerospace, telecommunications, chemicals, electronics and military equipment.
For the past three years, United States still remains a key engine of the global economy, serving as the source of aggregate demand for the world economy as the world’s export-oriented economies sell record amounts in the United States. While this has helped sustain aggregate demand in many countries where it would otherwise have been even weaker, the United States has run large current account deficits in trade with its major trading partners. Following robust growth of an average 3. 9 percent in 2004 (see Figure 1), the U.
S. economy continued to grow strongly in 2005 and 2006, even in the face of a withdrawal of monetary stimulus and high oil prices. Real GDP registered growth of 3. 2 percent in 2005 and 3. 3 percent in 2006, with household spending remaining the principal driver of the expansion, spurred by mortgage borrowing and double-digit house price inflation. Business investment also remained robust, supported by declines in capital goods prices, the economic expansion, and high profits despite higher interest rates.
However, the economy has cooled recently, largely reflecting a drag from residential investment as the housing market has weakened substantially. Weakness in business investment and net exports, as well as an inventory correction, amplified the downturn in early 2007 (Amiti & Stiroh, September 2007). As a result, real GDP growth is expected to slow to 2. 2 percent in 2007. Figure 1. US Quarterly Gross Domestic Product Growth in % from 2004 to 2007 (Source: EIU Data Services). Kemm (2007) expected that interest rates will remain high through the end of the second quarter as the Fed kept the federal funds rate at 5.
25 percent. As a result, housing expenditures will be soft at best. Softer housing expenditures will spill over to lower expenditures on consumer durables as well. However, generally low unemployment (4. 6 percent in January) and lower gasoline prices are expected to dampen overall potential declines in consumer spending. With continuing strong domestic demand, the current account deficit, which hit $880. 3 billion in the third quarter of 2006, could reach a trillion dollars in 2007.
Kemme (2007) warned that a weaker dollar will be seen to go against freely-traded currencies, the Euro in particular, and expected stronger exports to the Euro area will prevent new record trade deficits. There will be no significant weakening against the Chinese Yuan since that rate is controlled by the Chinese Central Bank. Thus, currency adjustments will have no impact on the bilateral US – Chinese trade deficit, which is expected to be deeper into the red. Consumer prices increased 2. 5 percent (annualized) in December, but Fed policy has been designed to bring inflation back down late this year.
Wild cards for the U. S. economy remain the price of oil, which is expected to remain high, and the war in Iraq. If the war in Iraq turns ugly (or uglier) or spills over into Iran, there could be dramatic material and psychological effects on the global economy. A disruption in oil supplies and higher-than-expected oil prices generating higher-than-expected inflation and interest rates could push a slow-growing U. S. economy into a recession. Since the current housing recession in the United States got under way in the fall of 2005, most economists saw it coming and anticipated a sharp decline in home building.
Homebuilding as measured by residential investment in the GDP accounts has now declined for five consecutive quarters in real terms, falling cumulatively 13% from third-quarter 2005 to fourth-quarter 2006. But homebuilding only accounts for about 6% of GDP. Thus, it only subtracted an average of 3/4% from real GDP growth over the course of 2006. And so far, with house prices adjusting relatively gradually in most markets, consumer spending has held up remarkably well. It has contributed an average of 2 1/2% to real GDP growth over the past four quarters, 1/2% more than in 2005 (Johnson, May 2007).
With sustained strong growth and increases in oil and commodity prices, resource utilization increased leading to the increase in inflation from 2. 7 percent in 2004 to 3. 4 percent in 2005 and 3. 2 percent in 2006. In the meantime, employment remains strong, and unemployment has continued to fall, to 4. 7 percent in 2006 from 5. 1 percent in 2005. In 2007, it is expected to remain in the 4. 7 percent level (See Figure 2). Figure 2. US Unemployment Rate in % from 2004 to 2007 (Source: EIU Data Services). According to the Country Insight (24 August 2007), agriculture still accounts for just 1.
0% of GDP and is predominately large scale and generally efficient. The US is a major exporter of foodstuffs and processed foods. The country’s manufacturing sector contributes 12. 1% of GDP and leads the way in the information technology revolution. However, the most prominent industries include aerospace, telecommunications, chemicals, electronics and computers. Manufacturers have finally begun to add new jobs. Previously, job growth was concentrated in the service sector and paid well below the national average, while jobs in higher-paying industries continued to shrink.
Now, some traditional manufacturing sectors have recorded dramatic gains in productivity and grown strongly by embracing new technology. But others have struggled, relying increasingly on imported components and even finished products. Among the latter are older industries such as steel, textiles, clothing and assembly-based operations. The huge automobile industry continues to struggle. The industry has cut tens of thousands of jobs and closed dozens of plants since 2006. The situation improved in the first half of 2007 but car sales could slump once again if the troubles in the housing and credit market hit consumer confidence.
Fiscally speaking, Hoagland (2007) revealed that the federal budget balance has turned from a surplus of US$128 billion in 2001 to continued deficits since 2002 because of tax cuts and growing spending on military and homeland security. The budget deficit reached US$413 billion in 2004, or 3. 6 percent of GDP, due to spiraling costs for national security, the war on terrorism and the war in Iraq. As a result of expenditure discipline and buoyant federal tax revenues, the budget deficit was reduced to US$318 billion (2. 6 percent of GDP) in 2005, and further down to US$248 billion in 2006 (1.
9 percent of GDP). In terms of the balance of payments, the U. S. current account has been in deficit because of the large deficit in the merchandise trade balance. The deficits have steadily increased in recent years mainly driven by sustained strong growth in imports of consumption and capital goods and higher oil prices. In 2005, the merchandise trade deficit reached a record US$783 billion from US$670 billion in 2004, driven by higher oil prices and continued strong import growth. As a result, the current account deficit widened to 6. 1 percent of GDP in 2005 from 5.
5 percent of GDP in 2004. In 2006, the current account deficit stayed unchanged at 6. 1 percent of GDP, with stronger export growth partly offsetting the impact of higher oil prices and lower net investment income (EIU ViewsWire, 15 August 2007). Despite the subprime crunch and the weakening of the dollar, the United States has remained an attractive destination for foreign capital — a factor that has helped finance its huge current account deficit in recent years. Besides strong economic fundamentals and sound monetary policy, the ability of U. S.
financial markets to intermediate domestic demand with foreign supply of funds has contributed to sustaining foreign capital inflows and the support of the dollar exchange rate. However, the Country Insight (24 August 2007), did not have a rosy picture to paint for the future of the U. S. economy. They listed seven urgent issues that the U. S. government needs to focus on: • In 2006, the national saving rate reached its lowest level in 70 years and continues to fall. The ratio of household liabilities to after-tax income is relatively high, around 130% in 2006. • Washington predicts that the deficit will be cut to 1.
6% of GDP by 2008 and then plunge to 0. 3% by 2012. However, a critical assumption is that the costs of the war in Iraq and Afghanistan will be nil in 2010 and beyond. • The current account deficit is expected to reach 7% of GDP in 2007. This benchmark is much larger than for any other industrialized country except Spain. • The country’s potential rate of growth is falling and could drop to around 2. 5% before the end of this decade. This would be the lowest rate in over a century. • Spending on Social Security, Medicare, and Medicaid currently account for over two-fifths of federal spending and is rising at an unsustainable rate.
• Washington expects growth to exceed 3% in both 2008 and 2009. The central bank forecasts growth of GDP to be 3. 3% per year over the next 10 years along with productivity growth of 2. 0% per year. • Residential construction accounts for more than 6% of GDP and analysts forecast a drop of 10%-15% during 2007. This would affect growth directly and have a negative impact on consumer sentiment. As we are aware that the economy is slowing, mainly due to problems in the housing and home mortgage markets, the US government needs to look into the subprime crisis more intently before it affects the U.
S. economy terribly. Growth of private consumption remains strong but could fall to around 2. 4% by 2008. Business investment has weakened but is expected to rebound owing to a rise in corporate profits and the lack of excess capacity. The housing market has deteriorated dramatically, prompting a significant withdrawal of support for household spending. In the first quarter of 2007, almost 7% of homeowners faced “negative equity”, meaning that their homes were worth less than their mortgages. The ratio of household liabilities to after-tax income was around 130% in 2006.
So long as interest rates were low, such debt could be financed relatively easily. But as interest rates have risen, the cost of financing has also reached new highs – nearly 19% of disposable income in 2006. A range of tax cuts approved in 2001-05 will also expire in 2010, and these are likely to be extended only with substantial modifications. A reform of the alternative minimum tax will become increasingly pressing. Public finances leave little room for more tax cuts, and demographic ageing will require a major review of entitlement programs in the long term.
There will also be some discussion of immigration reform to facilitate access to guestworker status and to legalize the status of unregistered aliens, although this is now likely only later in the forecast period after a series of defeats in 2007 (EIU ViewsWire, 26 October 2007). Unemployment is not really a problem for the past three years. There are over three million jobs were created in 2005 and 2006. However, real wages did not rise. In fact, the median wage has fallen. This result contrasts with previous US recoveries, when wage growth began to overtake inflation at a much earlier stage in the cycle.
Unemployment is expected to edge upward now that the economy has begun to slow. The current account deficit reached 6. 4% of GDP in 2006 and is expected to reach 7% in 2007. This benchmark is much larger than for any other industrialized country except Spain. Recent increases make it important to boost private saving and make more progress in fiscal consolidation. Despite withdrawal of a monetary stimulus and high energy prices, the U. S. economy has remained a key engine of global growth. Robust U. S. economic growth has provided a substantial boost to the world economy, with U. S.
net imports having led to growth in the rest of the world. In this background, however, the global imbalances have deteriorated; high current account deficits and increasing debt exist in the United States as well as corresponding surpluses in Japan and many other Asian emerging market economies. However, there is a concern about the risks of a disorderly resolution of imbalances, which could significantly lower growth in the United States and abroad. This illustrates the need for a cooperative global adjustment strategy by which the U. S. would increase national saving by more ambitious fiscal consolidation.
Also necessary are steps toward greater exchange rate flexibility in emerging Asia and continued structural reforms to boost growth in Europe and Japan. Also, reforms are urgently needed to put healthcare and social security on a sustainable path. Recent legislation will make it easier for employers to offer pension plans that require employees to “opt out” rather than “opt-in”. The change should lead to higher enrolment. Also, the government should continue to find ways to simplify the country’s complex and somewhat inefficient tax system, but it is unlikely that any fundamental reforms will be made before the next change in administration.
Corporate taxes are higher than in many European countries. In this regard, although there was an economic upswing that in 2004 and 2005 driven by domestic demand, the 2006 and 2007 pace of growth slowed down as a result of a weaker housing market, energy prices and interest rate increases. The key challenge for the U. S. economy to rise again is to restore fiscal surpluses and to pay down the federal debt ahead of the retirement of the older generation, while moving rapidly on entitlement reform.Sample Essay of EduBirdie.com