The best way to understand the evolution of the U.S. economy's level of production and employment since the mid-2000s is to look at four key components of spending: exports, business equipment investment, government purchases, and housing. Exports are driven by the exchange rate and foreign demand; equipment investment is driven by businesses' free cash flow, their cost of financing, and their perceived need for new capacity; government purchases are driven by politics; and housing construction is driven by housing prices, by interest rates, and by lending standards.
Scale all four of these by potential GDP, and examine the deviations of these four spending flows from their business-cycle peak values. We then see that the period since the mid-2000s falls into five segments:
- Recovery and housing boom;
- Rebalancing at full employment;
- The crash;
- The period of fiscal expansion; and
- "Green shoots"
Recovery and Housing Boom
Rebalancing at Full Employment
The Period of Fiscal Expansion