Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and headed the Council of Economic Advisers and the National Economic Council under President Clinton.
The last few years have begun with rosy expectations for an acceleration of growth in the United States economy, and this year is no different. This time, however, the rosy expectations are more likely to be realized. After several years of lackluster growth around 2 percent, forecasters are predicting that the economy will enjoy its strongest growth since the 2008 recession, with growth in the 3 percent range. There are plenty of reasons for optimism. But there are also plenty of reasons that optimism should be tempered with caution and with concern about the prospects for sustainable and equitable growth.
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Equity and home values have risen, restoring real household net worth to its prerecession peak. Residential investment continues to strengthen, although it is still below its prerecession rate as a share of gross domestic product; house prices are rising; and the number of underwater mortgages, mortgage delinquencies and foreclosures has declined significantly.
The fiscal position of state and local governments is improving, and they are adding rather than cutting jobs. Employment by the federal government continues to decline, but federal fiscal austerity is easing. As a result of the recent budget deal, the federal budget is on course to subtract only about 0.5 percent from G.D.P. in 2014, compared with a whopping 1.75 percent in 2013. Congressional fiscal follies, with destabilizing showdowns over the debt limit and government shutdowns, appear to be on hold at least for the 2014 midterm election year.
As these headwinds dissipate, monetary policy is likely to remain highly accommodative. At its last meeting, the Federal Reserve reiterated its intention to hold the federal funds rate near zero well past the time that the unemployment rate falls to 6.5 percent and to trim its asset purchases by only a modest amount. Policy continuity is expected when Janet Yellen becomes the Fed chief this month, as she has been a vocal co-architect of the Fed’s accommodative monetary stance.
The combination of stronger household balance sheets, a rebounding housing market, less fiscal restraint and continued monetary accommodation bodes well for the economy’s growth in 2014. So does the fact that job creation is gaining momentum. Improving job prospects have strengthened consumer confidence, which should fuel stronger consumption growth.
More robust consumer demand along with record high profits and the largest annual gain in stock prices in two decades should encourage investment spending. Annual net nonresidential fixed investment in physical structures, equipment and software, measured in constant dollars, is still below its prerecession level as a share of G.D.P.
The reshoring of economic activity to the United States and the decline in the trade deficit in response to relatively cheaper energy and labor costs in this country, along with a weaker dollar, should also strengthen domestic demand and encourage more business investment. The trade deficit fell to a four-year low, and exports rose to a record high last November. As a result of the vast increase in domestic shale energy, the United States is becoming more energy independent, a trend that will continue this year. On an inflation-adjusted basis, the trade deficit in petroleum goods is at its lowest level in more than four decades.
According to a recent analysis by the McKinsey Global Institute, shale energy and big data analytics, areas in which the United States has a strong competitive lead, could be significant “game changers” for growth on the supply side if demand is strong enough to drive private-sector investment. The signs are promising. A recent study by the Progressive Policy Institute found that telecommunications companies, technology companies and energy companies were the largest sources of private investment spending in 2012.
Lest all the recent good news engender irrational exuberance, it is sobering to recall the many risks that could undermine the economy’s growth this year. There are unknowable risks from unforeseen natural disasters, such as the tsunami in Japan that unexpectedly slowed growth in 2012, and from geopolitical crises.
Foreign and domestic policy uncertainties also pose risks. Will the success of Abenomics be resilient or short-lived? Will China be able to write off and contain the bad debts of its banks and local governments without a sharp slowdown? Will Europe move forward on its banking reform? Will a gradual tapering in the Fed’s bond-buying program, even with active forward guidance, rattle global capital markets and lead to a sudden and sizable increase in long-term interest rates? A Goldilocks exit from the Fed’s unconventional policies is a policy goal, but by no means a certainty. Nor is it a certainty that Congress will raise the debt limit without another round of destabilizing brinkmanship.
Optimism about the future should also be tempered by recognition of where the economy is today and what it has lost since the recession. Even with more rapid growth this year, output and employment will remain far below prerecession trend lines for several years. Output fell 8 percent relative to its noninflationary potential in 2008-9 and is now around 10 percent lower than what was judged to be its potential in 2007.
Five years of anemic aggregate demand have discouraged risk taking, new business formation, and investment in capital and research and development. As a result, the economy’s potential growth rate has fallen by about a percentage point.
The possibility that the United States economy may be mired in long-term secular stagnation, a hypothesis recently espoused by Lawrence Summers, is another reason for caution when evaluating recent good economic news. Even before the recession, output and employment growth were disappointing despite very low interest rates and easy credit market conditions that fueled a housing bubble. Is aggregate demand so weak that full employment requires negative real interest rates and the attendant risks of recurrent financial crises for a sustained period of time? The secular-stagnation argument suggests that the answer is yes: Stronger growth cannot be achieved by sustainable monetary policy alone, and increases in government spending and additional fiscal measures to foster private demand are required. But more expansionary fiscal policy is unlikely in the current political environment.
Another reason for tempered optimism about the economy’s 2013 prospects is the likelihood that income inequality will continue on its upward trajectory despite a pickup in growth. In the short run, as has been painfully obvious in the last few years, a weak economy and persistent joblessness can worsen income inequality. By the same labor market logic, stronger growth this year should reduce labor-market slack, increasing labor’s bargaining power and leading to healthier wage gains for a larger percentage of workers.
In the long run, however, there appears to be no systematic link between economic growth and income inequality. So a rosier outlook for growth this year should not be seen as a harbinger of more equitable growth over time.
There are grounds for optimism about the economy’s prospects this year, but there are grounds for caution and concern as well.