	Background

		Severity of the 2008-2009 Recession

The 2008-2009 recession was long and deep, and according to several indicators was the most severe economic contraction since the 1930s (but still much less severe than the Great Depression). The slowdown of economic activity was moderate through the first half of 2008, but at that point the weakening economy was overtaken by a major financial crisis that would exacerbate the economic weakness and accelerate the decline. Congress was an active participant in the emergence of these policy responses and has an ongoing interest in macroeconomic conditions. Current macroeconomic concerns include whether the economic recovery will be sustained, reducing unemployment, speeding a return to normal output and employment growth, and addressing government's long-term debt situation. Moreover, in 2011-2012, the sharply fading effects of fiscal stimulus and weaker growth in Europe have likely dampened economic growth. The Shape of Economic Recovery

In the typical post-war business cycle, lower than normal growth of aggregate demand during the recession is quickly followed by a recovery period with above normal growth of spending, perhaps spurred by some degree of monetary and fiscal stimulus. This above normal growth brings the economy back more quickly to the pre-recession growth path, and speeds up the reentry of the unemployed to the workforce. There is concern, however, that this time the U.S. economy, without supporting stimulus from policy actions, will either not return to its pre-recession growth path, perhaps remain permanently below it, or return to the pre-crisis path but at a slower than normal pace, or worse, dip into a second recession. The next sections of this report discuss problems on the supply side and the demand side of the economy that could lead to a weaker than normal recovery. Has the recent financial crisis caused a reduction in the potential output of the U.S. economy and placed it on a lower trend growth path? Policy Responses to Increase the Pace of Economic Recovery

The momentum of the current economic recovery has been assisted by injections of fiscal and monetary stimulus. In regard to the long-term debt problem, it is often pointed out that for an economy operating close to potential output, government borrowing to finance budget deficits will draw down the pool of national saving, leaving less available to support private capital investment. However, the U.S. economy is currently operating well short of capacity and market interest rates are generally at or near historical lows, making the risk of such "crowding out" occurring and damaging future economic growth not seem immediate. Once the short-term problem of weak demand is solved and the economy has returned to a normal growth path, the appropriate policy response for an economy with a looming debt crisis is arguably fiscal consolidation—cutting deficits. Such a policy is thought to have the benefits of low and stable interest rates, a less fragile financial system, improved investment prospects, and possibly faster long-term growth. A Lesson from the Great Depression

One of the important lessons from the Great Depression is to avoid a hasty withdrawal of fiscal and monetary stimulus in a fragile economy still recovering from a sharp economic decline.
The 2007-2009 recession was long and deep, and according to several indicators was the most severe economic contraction since the 1930s (but still much less severe than the Great Depression). The slowdown of economic activity was moderate through the first half of 2008, but at that point the weakening economy was overtaken by a major financial crisis that would exacerbate the economic weakness and accelerate the decline.
Economic recovery began in mid-2009. Real gross domestic product (GDP) has been on a positive track since then, although the pace has been uneven and slowed significantly in 2011. The stock market has recovered from its lows, and employment has increased moderately. On the other hand, significant economic weakness remains evident, particularly in the balance sheet of households, the labor market, and the housing sector.
Congress was an active participant in the policy responses to this crisis and has an ongoing interest in macroeconomic conditions. Current macroeconomic concerns include whether the economy is in a sustained recovery, rapidly reducing unemployment, speeding a return to normal output and employment growth, and addressing government's long-term debt problem.
In the typical post-war business cycle, lower than normal growth during the recession is quickly followed by a recovery period with above normal growth. This above normal growth serves to speed up the reentry of the unemployed to the workforce. Once the economy reaches potential output (and full employment), growth returns to its normal growth path, where the pace of aggregate spending advances in step with the pace of aggregate supply. There is concern that this time the U.S. economy will either not return to its pre-recession growth path but perhaps remain permanently below it, or return to the pre-crisis path but at a slower than normal pace. Problems on the supply side and the demand side of the economy have so far led to a weaker than normal recovery.
If the pace of private spending proves insufficient to assure a sustained recovery, would further stimulus by monetary and fiscal policy be warranted? One lesson from the Great Depression is to guard against a too hasty withdrawal of fiscal and monetary stimulus in an economy recovering from a deep decline. The removal of fiscal and monetary stimulus in 1937 is thought to have stopped a recovery and caused a slump that did not end until WWII. Opponents of further stimulus maintain that the accumulation of additional government debt would lower future economic growth, but supporters argue that additional stimulus is the appropriate near-term policy. Moreover, in 2011-2012, the sharply fading effects of fiscal stimulus and weaker growth in Europe have likely dampened economic growth.
In regard to the long-term debt problem, in an economy operating close to potential output, government borrowing to finance budget deficits will in theory draw down the pool of national saving, crowding out private capital investment and slowing long-term growth. However, the U.S. economy is currently operating well short of capacity and the risk of such crowding out occurring is therefore low in the near term. Once the cyclical problem of weak demand is resolved and the economy has returned to a normal growth path, mainstream economists' consensus policy response for an economy with a looming debt crisis is fiscal consolidation—cutting deficits. Such a policy would have the benefits of low and stable interest rates, a less fragile financial system, improved investment prospects, and possibly faster long-term growth.