The nature of this process can be usefully illustrated with a simple, but important accounting identity based on the difference between current income and expenditure in each of the nonfinancial sectors of the economy. For each sector, this difference we call the balance. If the economy were isolated from the rest of the world, then government-sector balance and private-sector balance would add up to zero. In real life, of course, we have a foreign sector, too. If the United States in total spends more than it earns, that must be offset by foreigners spending less than they earn and vice versa. When domestic expenditures exceed income, this produces a deficit in the current account balance. Putting these pieces together we have: government-sector balance + private-sector balance = current account balance. As can be seen in Chart 3, when the crisis hit, the private-sector balance moved quickly into positive territory as households in general tried to save more, and this was accommodated by a record government deficit and a smaller current account deficit. More recently, the private-sector surplus has declined and the government deficit has decreased, with little change in the external balance. This distribution of surplus and deficit across the economy’s different sectors illustrates a substantial challenge for U.S. economy. In the early stages of adjustment, it was quite appropriate for the government to offset part of the sharp increase in private-sector net saving with increased borrowing. If this had not occurred, the recession would have been even deeper.

Employment dropped sharply during the recession, contributing to a sharp rise in the unemployment rate from around 4.5 percent in the middle of 2007 to over 10 percent in October 2009. Extraordinary actions by authorities around the world, including the Federal Reserve, prevented full-scale financial and economic collapse, and the global economy stabilized around mid-2009. But since then, the recovery has been bifurcated. While emerging economies have rebounded rapidly, the developed world has grown only slowly. This has hastened a historic shift in the balance of economic power that was already underway before the crisis. In the United States, the recovery has proven to be persistently weaker than expected. Growth has been insufficient to either bring down unemployment significantly or to achieve a self-reinforcing cycle of strengthening confidence, demand, income and employment. Although the latest news on the U.S. economy is somewhat more encouraging than that from earlier in the year, we should not take much solace from that. After a very weak first half, when growth was less than one percent, economic activity has strengthened somewhat and inflation pressures are starting to ease. Growth in the third quarter is currently estimated 2.5 percent, and recent indicators suggest growth in the fourth quarter could be somewhat higher. However as we look toward 2012 the U.S. economy continues to face several obstacles to a robust economy. Accordingly, I expect growth of about 2.75 percent for 2012, not much higher. We also continue to face significant downside risks, mostly related to the stress in the eurozone.