Economic growth

Added December 2020


Economic growth is determined by productivity, the quantity of goods and services produced from each unit of labor input. Productivity is determined by the supply of physical capital (equipment and structures), human capital (knowledge and skills), natural resources, and technological knowledge. Government policy can encourage productivity by influencing saving and investment, education, health and nutrition, property rights and political stability, free trade, research and development, and population growth.

The Great Depression was the largest economic downturn in U.S. history. Real GDP fell by 26 percent from 1929 to 1933, and unemployment rose from 3 percent to 25 percent. This was mainly caused by problems in the banking system, which led to a decline in the money supply and reduced investment spending, and therefore a collapse in aggregate demand. The economy later boomed when, as the U.S. entered World War II, the government increased its purchases of goods and services.

The Great Recession of 2008–2009 was the worst macroeconomic event in more than 50 years. Real GDP fell by 4 percent, and unemployment rose to 10 percent. The recession was caused by developments in the housing market. During the housing boom of the early 2000s, banks and insurance companies made it easier for subprime borrowers to get loans to buy homes by bundling the loans into high-risk mortgage-backed securities and selling them to other institutions. When house prices fell, a rise in mortgage defaults and home foreclosures led to a collapse in residential investment, and to large losses in financial institutions, producing a credit crunch. In response, the Fed cut interest rates and bought debt (quantitative easing); and Congress appropriated $700b to rescue the financial system by injecting capital into banks, and $787b to stimulate the economy. The economy began to recover in June 2009, but the recovery was meager by historical standards.

Resource: Mankiw 2019