U.S. outlook for 2009.

• Author: Witte, Willard E.

November 2008, updated December 2008

A year ago, in our expectations for 2008, we began: During the past year, the U.S. economy has essentially been in survival mode. The good news as the year draws to a close is that we seem to have avoided intensive care. The not-so-good news is that the impediments to full recovery are not diminishing." That last sentence has turned out to be a masterpiece of understatement. And the next sentence--"Nevertheless, we expect the economy will avoid a crisis and continue to muddle through"--was clearly an example of misplaced optimism.

Output growth in the United States decelerated for the fourth straight year during 2008. On a fourth-quarter to fourth-quarter basis, 2008 real gross domestic product (GDP) will probably show only minimal growth. (Fourth quarter data were not available at the time of this writing.) The last time the economy approximated its long-run potential (about 3 percent growth) was in early 2006 (see Figure 1).

The labor market shows a similar pattern (see Figure 2). During 2005, the economy was adding over 210,000 jobs each month. This slowed to 175,000 per month in 2006, and to 91,000 in 2007. So far this year, the economy has been losing over 170,000 jobs per month, with the rate of loss increasing as the year has proceeded. In order to absorb new entrants into the labor force (for example, young people graduating from high school or college), the economy must generate about 140,000 new jobs each month. When this is not achieved, as has been the case since early 2007, unemployment rises. During this period, unemployment has gone from a low 4.4 percent to a November level of 6.7 percent, with worse yet to come.

[FIGURE 1 OMITTED]

[FIGURE 2 OMITTED]

Three fundamental problems have contributed to this dismal performance. The starting point was the continuing implosion in the housing sector. Since peaking in late 2005, the decline has been dramatic. Housing starts, for example, have fallen by well over 50 percent, and it will probably be at least the middle of 2009 before any real improvement occurs. The weak sales environment has also become evident in housing prices, which have been under unprecedented pressure throughout the country. As a result, record numbers of homeowners face foreclosure. Moreover, since a house is the largest asset for most households, the decline in home values has dealt a severe blow to consumer confidence in general.

The second source of negative pressure is the...