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Tuesday, September 24, 2013

Rebuilding Household Wealth: Implications for Economic Recovery

Craig K. Elwell
Specialist in Macroeconomic Policy

The pace of economic recovery from the 2007-2009 recession has been historically slow. Over four years of recovery, the annual rate of growth of real gross domestic product (GDP) has averaged 2%, well below the 3% to 5% typical of other post-WWII recoveries. As a result, the output gap—the difference between what the economy could produce and what it actually produced—has only declined from a high of 8.1% in mid-2009 to a still large 5.8% in mid- 2013. Slow growth of output has translated into a slow reduction of unemployment.

The recovery has persisted, in part, due to support to aggregate spending by policies of fiscal and monetary stimulus. However, fiscal stimulus has steadily dissipated since 2010 and in 2013 the federal budget has turned contractionary. While monetary policy is expected to remain stimulative through 2013, it is unlikely to add to that stimulus to counteract the increasing drag of falling federal budget deficits on economic activity. Therefore, sustaining the recovery’s momentum in the remainder of 2013 and into 2014 may require a greater push from private spending, particularly household consumption spending.

In the aftermath of the 2007-2009 recession, which involved a substantial loss of net worth and increase in the burden of debt, households’ actions to repair their severely damaged balance sheets by reducing debt and building wealth is thought by many economists to be a key factor dissipating the strength of consumer spending. Although this repair is necessary for building a stronger economy in the long run, it has slowed the economy-wide recovery and job creation in the short run.

Where households currently stand in repairing their balance sheets is likely to influence the strength of consumer spending going forward. If substantially complete, it would point to the prospect of stronger consumer spending and increased momentum of the economic recovery; but if substantial wealth building is still needed, it would diminish that prospect.

A number of indicators paint a mixed picture of the prospect for stronger consumer spending. Despite clear progress, more repair of the severely damaged household balance sheet may be needed before households begin to spend at a faster pace. The typical household has likely only seen modest improvement in its net worth in large measure because the value of real estate, most often the largest asset it holds, has only recently been increasing. The rebound of the housing market portends progress for the typical household rebuilding its wealth, but it is unlikely that this process will be completed in 2013, making it also likely that tepid spending by consumers will continue.

Determining the state of household net worth has implications for the optimal policy response going forward. If household net worth is judged to have not fully recovered from the damage incurred in 2007-2009, particularly for the typical household, some may regard this as an indicator of a continuing need for macroeconomic policy to provide stimulus to maintain the recovery’s upward momentum. It could also have implications for federal policy measures that are aimed at providing direct help in removing the burden of household debt through programs that restructure mortgage debt.

Date of Report: September 13, 2013
Number of Pages: 19
Order Number: R43228
Price: $29.95

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