The U.S. economy has proven itself remarkably resilient over the past 8 years, having withstood a number of major shocks throughout the period. During the last few months of 2008, however, the economy encountered major shocks in the financial sector that it could not shake off.

Those financial shocks combined with other factors—record high commodity prices earlier in the year, natural disasters, and continued weakness in the housing market—to cause the economy to contract modestly in the third quarter and what appears to be a sharp decline in the fourth quarter (see Chapters 1 and 2). The contraction will likely last into early- or mid-2009.

 Despite rapid fiscal and monetary policy action in response to weakening economic conditions, the economy entered into recession at the end of 2007, ending 6 years of expansion and a record 52 months of uninterrupted job growth. Several factors contributed over many years to create the credit difficulties that reached crisis proportions late in the year.

The magnitude of the crisis required unprecedented policy responses to reduce the extent of the damage to the economy. These policy actions have laid a foundation for a strong economic recovery early in the term of the next Administration. Most market forecasts suggest the weakness will continue in the first half of 2009, followed by a recovery beginning in the second half of 2009 that will gain momentum in 2010 and beyond.

Despite the risk that recent events may overshadow the many positive developments of the past 8 years, there have been major policy advances that have improved the long-term prospects of our economy and strengthened its foundation. Much of this Report examines the effects of pro-growth economic policies and market-based reforms adopted during the Administration, as well as policy considerations that will further improve the long-term position of our economy and allow more Americans to realize the benefits of economic expansion in the future.

Record-high energy prices in 2008 highlighted our economy’s dependence on fossil fuels and underscored the need to diversify our national energy portfolio. Although it will take time and major technological breakthroughs to substantially reduce our dependence on fossil fuels, the Administration has invested unprecedented levels of Federal resources and adopted a number of policies that have helped advance the economy’s transition to new sources of energy while reducing local and regional pollutants in responsible ways that do not threaten our economic well-being (see Chapter 3).

Export performance was one of the bright spots in the economy over the past several years, and played an important role in offsetting other areas of weakness in the economy. The United States’s continued commitment to open trade and investment policies will be an important factor in maintaining the international competitiveness and the dynamic nature of our economy (see Chapter 4).

 Lower tax rates have also contributed to economic performance by easing the burden on labor and capital and enabling firms, investors, and consumers to allocate resources more efficiently (see Chapter 5). These policies, which contribute to the increased flexibility of the economy, will be important in facilitating the economic recovery going forward. There remains considerable opportunity to strengthen our economic position by eliminating the uncertainty surrounding tax relief that is scheduled to expire.

In addition, rising health care costs and spending on entitlement programs are ongoing areas of concern, and the Administration has offered reforms that could substantially lower costs and improve our fiscal position (see Chapters 6 and 7). Education is essential to future prosperity, and the Administration has taken several steps to improve kindergarten through twelfth-grade education and to make college more affordable (see Chapter 8).

Finally, as highlighted by the recent financial crisis, there are several areas in which regulatory reforms are necessary and appropriate to address market failures. The Administration has pursued market-oriented regulatory reforms that favor individual choice over Government decision making wherever appropriate, and this approach has proven effective in addressing market failures without imposing excessive costs on society or the economy (see Chapter 9).

Download The Economic Report of the President 2009

PDF format, 5.5MB, 419Pages.

Transmitted to the Congress January 2009
Together with THE ANNUAL REPORT
of the COUNCIL OF ECONOMIC ADVISERS
UNITED STATES GOVERNMENT PRINTING OFFICE
WASHINGTON : 2009
ISBN-13: 978-0-16-077918-3

CONTENTS
Overview............................................................................................. 19
Chapter 1. the year in review and the years ahead...................... 31
Developments in 2008 and the Near-Term Outlook....................... 33
Consumer Spending and Saving.................................................. 33
Residential Investment................................................................ 39
Business Fixed Investment........................................................... 41
Business Inventories.................................................................... 43
Government Purchases................................................................ 43
Exports and Imports.................................................................... 44
Employment................................................................................ 45
Productivity................................................................................. 46
Prices and Wages......................................................................... 46
Financial Markets........................................................................ 50
The Long-Term Outlook Through 2014......................................... 53
Growth in GDP over the Long Term......................................... 55
A Perspective on the Past Eight Years.......................................... 56
Conclusion....................................................................................... 58
Chapter 2. housing and financial markets.................................... 61
Origins of the Crisis......................................................................... 63
The Global Saving Glut.............................................................. 63
The Global Credit Boom and the Housing Market.................... 64
The Credit Crunch..................................................................... 69
Leverage and Reliance on Short-Term Funds.............................. 71
Macroeconomic Consequences of the Crisis..................................... 72
Banks Reduced Lending to Consumers and Businesses............... 73
The Onset of the Crisis............................................................... 74
Credit Market Investors Reduced Lending to Businesses............. 75
The Effect of the Crisis on the Non-financial Economy............. 77
Policy Responses to the Crisis.......................................................... 79
Policy Responses in 2007............................................................ 79
Policy Responses in 2008............................................................ 80
Results So Far................................................................................... 85
Looking Forward.............................................................................. 87
Developing a New Regulatory Structure for Financial Markets... 87
Unwinding Temporary Programs................................................ 89
Modernizing Financial Regulation.............................................. 90
The Future of Mortgage Financing and Fannie Mae and
Freddie Mac..................................................................................... 93
Conclusion....................................................................................... 96
Chapter 3. energy and the environment........................................ 97
U.S. Energy Use and Policy Goals.................................................... 98
The Promise of Market-Oriented Policy Approaches....................... 100
Market-Oriented Environmental Regulation.................................... 100
The Role for Technology Inducement Policies............................ 101
Increasing Use of Alternative Energy Sources................................... 103
Generating Electricity.................................................................. 104
Alternative Transportation Fuels................................................. 106
Harnessing Existing Energy Sources More Responsibly.................... 109
Increasing Efficiency.................................................................... 109
Cleaner Use of Fossil Fuels.......................................................... 112
Removing Regulatory Impediments to Domestic Production..... 116
Overarching Challenges.................................................................... 116
Balancing Local, Regional and Global Goals............................... 117
Efficient R&D Support for Alternative Energy Sources.............. 118
Economically Efficient Regulation under Existing Statutes......... 119
Global Action on Climate Change.............................................. 123
Conclusion....................................................................................... 126
Chapter 4. the benefits of open trade and investment policies. 127
Trade and Investment in the United States...................................... 128
Openness to Trade and Investment Has Substantially
Contributed to U.S. Growth................................................... 129
The Benefits of Free Trade............................................................... 130
Free Trade Agreements................................................................ 132
Reductions in Tariffs................................................................... 134
The Benefits of Open Investment.................................................... 136
U.S. Investment and Investment Policy...................................... 139
Foreign Investment Policy........................................................... 144
Development Assistance Initiatives................................................... 144
Millennium Challenge Corporation............................................ 146
Trade Capacity Building............................................................. 146
Investment Promotion Programs................................................. 147
Trade Preference Programs.......................................................... 148
Trade Policy Going Forward............................................................ 149
Conclusion....................................................................................... 150
Chapter 5. tax policy........................................................................ 151
Individual Income Tax Reform........................................................ 152
Lowering Tax Rates Stimulates Economic Growth..................... 153
A Record of Tax Reform.................................................................. 159
Lower Tax Burdens..................................................................... 161
Pro-Growth Business Tax Reform.................................................... 162
Reducing the Double Taxation of Corporate Income................. 162
Accelerating Depreciation Allowances......................................... 163
Increasing Small Business Expensing........................................... 164
Tax Credits for Research and Development................................ 164
International Competitiveness.......................................................... 165
Future Challenges............................................................................. 166
Making Tax Relief Permanent..................................................... 166
Fixing the Alternative Minimum Tax.......................................... 168
Simplifying the Tax Code........................................................... 170
Conclusion....................................................................................... 172
Chapter 6. the long-run challenges of entitlement spending.. 175
Background Facts about Entitlement Programs................................ 176
Social Security............................................................................. 176
Medicare..................................................................................... 177
Medicaid..................................................................................... 178
Major Entitlement Spending Over Time.......................................... 180
Social Security............................................................................. 181
Medicare and Medicaid............................................................... 184
Factors That Drive Expenditure Growth Over Time....................... 187
Demographic Shifts..................................................................... 187
Increased Health Care Spending Per Beneficiary......................... 188
The Bottom Line........................................................................ 189
The Financial Future of Social Security............................................ 189
Addressing Future Solvency......................................................... 189
Funding Future Benefits ............................................................ 190
The Financial Future of Medicare and Medicaid.............................. 192
Conclusion....................................................................................... 195
Chapter 7. balancing private and public roles in health care... 197
The Health of the U.S. Population.................................................. 198
U.S. Health Care Spending.............................................................. 200
Improving the Effectiveness and Efficiency of Health Care.............. 202
Health Information Technology.................................................. 203
Comparative Effectiveness........................................................... 203
Price and Quality Information Transparency.............................. 204
Pay-for-Performance.................................................................... 205
Using Market-Based Approaches to Improve Access to Health
Insurance................................................................................ 206
Private Health Insurance...................................................................... 206
Public Insurance.......................................................................... 210
The Uninsured............................................................................ 212
Investing in Public Health................................................................ 214
Strengthening Community-Based Health Care........................... 214
Preparing for Public Health Emergencies.................................... 214
Supporting Research.................................................................... 214
Promoting Global Health Improvement..................................... 215
Conclusion....................................................................................... 216
Chapter 8. education and labor...................................................... 217
Economic Benefits of Education...................................................... 218
Primary and Secondary Education.................................................... 221
Early Signs of NCLB Success...................................................... 221
NCLB Challenges....................................................................... 223
Higher Education............................................................................. 225
College Preparedness................................................................... 226
Funding Higher Education......................................................... 227
Labor Issues: Income Trends, Worker Flexibility, and Pension
Reform.................................................................................... 228
Recent Trends in Real Incomes................................................... 229
Worker Flexibility and Training.................................................. 231
Retiree Income............................................................................ 232
Looking Ahead................................................................................. 235
Income Inequality....................................................................... 235
Immigration Reform................................................................... 236
Conclusion....................................................................................... 237
Chapter 9. economic regulation..................................................... 239
Telecommunications and Broadband............................................... 241
New Technologies Permit Greater Competition in
Telecommunications................................................................... 241
Telecommunications Regulation in an Evolving Market............. 243
Spectrum Policy............................................................................... 244
Tort Reform..................................................................................... 247
Corporate Governance Reform......................................................... 249
Insurance Against Terrorism and Natural Disasters.......................... 251
Roads............................................................................................... 254
Aviation............................................................................................ 258
Conclusion....................................................................................... 259

LETTER OF TRANSMITTAL
Council of Economic Advisers
Washington, D.C., January 16, 2009

Mr. President:
The Council of Economic Advisers herewith submits its 2009 Annual Report in accordance with the provisions of the Employment Act of 1946 as amended by the Full Employment and Balanced Growth Act of 1978.

Sincerely,
Edward P. Lazear
Chairman
Donald B. Marron
Member

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