Operation Twist
Four Years After the Wake-Up Call

The Shape of the Downturn

FRED Graph  St Louis Fed 4

this is not a bad way to look at (much of) what is going on in the current Lesser Depression. The boom of the 1990s had been driven by rising exports and, overwhelmingly, business investment in equipment investment and software as Bill Clinton's stabilization of the U.S. government's long-term finances and his shrinkage of the government had unleashed a high-investment, high productivity growth recovery. The recession of 2001 was driven primarily by a fall in exports and secondarily by a fall in business equipment investment. The mid-2000s recovery was led by residential investment, with exports and business equipment investment adding support.

That takes us up to the end of 2005.

With the start of 2006, the housing bubble bursts and residential construction investment begins to decline as a percentage of potential GDP. But for the first two and a half years exports stand up as housing construction stands down and the economy remains near an even keel even with the growing financial turmoil.

Then in late 2008 the economy falls off a cliff: business investment in equipment and software collapses, housing investment collapses further to far below any equilibrium level, and exports collapse. Exports and business equipment and software investment start to recover in the third quarter of 2009. If only their good recovery performance had been matched by a recovery in residential investment and an increase in government purchases, we would due fine.

But there was no recovery in residential construction. There was no increase in government purchases. And starting in 2010 the shrinking government sector puts additional downward pressure on the economy.