When the bust arrives, over-indebted households and businesses want to increase their saving and liquidity buffers, and financial intermediaries want to raise credit standards. Both responses restrain demand and make a cyclical rebound more difficult. In the U.S. case, because the bust was concentrated in housing, the scope for a strong cyclical recovery was particularly constrained because the interest-rate sensitive sector that would typically lead such a rebound could not recover until the overhang of unsold homes and the impairment of housing finances was corrected. The U.S. recovery has also been subpar because it has been taking place in the context of a weak global economy. Historically, after a country experienced a financial crisis, growing foreign demand and currency depreciation have often led to a sharp improvement in the trade account that has put a floor under economic activity. In such circumstances, rising exports substitute for domestic consumption in supporting aggregate demand. This demand, in turn, encourages businesses to hire and invest. In contrast, this time the shock generated by the U.S. housing bust had global consequences, exposing economic vulnerabilities outside of the United States, especially in Europe. Under these circumstances, the scope for trade as a support for U.S. growth, while positive, has been very limited. These two factors – the dynamics following financial crises and the weakness of foreign demand – help explain why U.S. growth has been weak, but I don’t think these factors explain why it has been consistently weaker than expected.

According to a 2011 Pew Research Center poll, more than 40 percent of people aged 18 – 30 believe they will receive no retirement income from Social Security, even though Social Security receipts are estimated to equal about 75 percent of benefits on a sustainable basis under the current regime.5 Congress and the White House should enact a fiscal program that starts with mild restraint, but credibly builds that restraint over time so as to put the nation’s debt burden on a clearly sustainable course. Ideally, the program would have broad bipartisan support and provide clarity not just on the near-term outlook, but also about how the major entitlement programs would be adjusted. Also, steps could be taken to increase the productive capacity of the economy over time. Such actions are desirable because a more productive economy will generate higher living standards and have greater fiscal capacity. Let me briefly mention a few steps that could be taken to increase the economy’s potential over time – immigration policies that attract workers with scarce skills to the United States; education policies and job retraining programs that build and replenish human capital; spending on infrastructure to remove bottlenecks; tax simplification and the elimination of tax policies that distort investment and saving decisions; regulatory policies that are attentive to costs and benefits and that emphasize getting the incentives right. Counter-cyclical policies and structural policies are not substitutes, they are complements. We need both. The strength of demand today is importantly influenced by expectations about future living standards.