The U.S. economy.

• Author: Witte, Willard E.

The performance of the U.S. economy during the past year is something of a paradox. A year ago, in our preview of the prospects for 2002, we forecast that the recession would probably end during the second quarter, with growth for the year of only 1 percent. We thought that inflation would be a little above 2 percent and that unemployment would average 6.3 percent. Each of these estimates has proved to be too pessimistic. In fact, the recession was clearly over by last spring. Output growth during the first three quarters of 2002 has averaged above 3 percent, while inflation (as measured by the consumer price index) has been below 1.5 percent over the past year. The unemployment rate is currently 6.0 percent, and the average for 2002 as a whole will be about 5.8 percent. Productivity growth has been strong. Overall, it was not a bad performance, and certainly better than expected.

The paradox is that it doesn't feel very good. Most people would probably say that the economy has worsened over the past year. Some of the reasons for this disconnect are easy to perceive. One is that the standard of comparison is set by the exuberance of the 1996-99 period, one of the best in U.S. economic history. As is shown in Figure 1, year-over-year output growth (real GDP) was consistently above 4 percent over that period, with quarterly spikes that often surpassed a 6 percent rate. By comparison, the 3 percent growth over the past year seems unsatisfactory. The same type of situation prevails in the labor market, as shown in Figure 2. Over the four-and-a-half years prior to mid-2000, the U.S. economy added over 3 million jobs per year. By contrast, during the five quarters prior to the middle of this year over 1.7 million jobs were lost. This is the dark side of rapid productivity growth. With rising productivity, fewer workers are needed to produce the same output. In the 1990 recession, it was three full years after the onset of the downturn before employment again reached its level at the cyclical peak. The current recovery may be on a similar trajectory.

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A second reason why the economic situation seems darker than the raw numbers is a tendency to think in terms of goods markets. Goods account for less than half of the value of total demand and less than a fifth of total employment, but they represent our image of what the economy is really about. During the recession, total output declined for three quarters and by a total of...