Moody’s Chief Economist Mark Zandi cites three reasons to be bullish about the U.S. economy: a housing revival, the end of deleveraging, and a healthy corporate sector that will be ready to invest in 2013. CFR’s A. Michael Spence also thinks that 2013 augurs better for the world economy, but cautions that lagging employment and income inequality will hamper a robust recovery.
In contrast, CFR’s Robert A. Kahn cautions that Europe’s debt crisis is far from being solved and that without growth, "we are likely to see Europe again at the brink." The Century Foundation’s Mark Thoma believes that a reevaluation of monetary policy in the United States, and possibly the Bank of England, could help lower the European Central Bank’s guard against inflation in the coming months.
Carnegie’s Yukon Huang predicts that even as the currency war between China and the United States recedes, the battle over foreign investment and technology transfer policies will continue to escalate in the coming months.
The economic outlook for the United States in 2013 is marginally brighter. The economy is adapting structurally, albeit slowly, to an altered and more sustainable growth pattern. The deleveraging process is further along, which, in turn, has spurred domestic demand. A divided Congress appears to be serious about reducing debt and long-term non-debt liabilities, and may come together around a credible stabilization path that will reassure business, reduce uncertainty, and boost investment. However, disruptive technology, global market forces, the education gap, and skills deficit mean that long-term unemployment will remain a problem. Looser monetary policy, designed to buy time for politicians to enact needed policy changes, may push the economy back toward the defective leveraged-growth model and delay long-overdue structural adjustments.
Europe experienced a substantial decline in systemic downside risk in the summer of 2012 as a result of credible reform momentum in Italy and Spain, as well as conditional but strong commitment by the ECB and the eurozone core to stabilize the banking sectors and the sovereign debt markets while those reforms take effect. Political uncertainty surrounding upcoming elections may cause a setback, but the most likely outcome is negative growth and high unemployment (especially for the young), not a disorderly unwinding of the eurozone.
Generally, the emerging economies look to be faring better. In 2012, the ongoing crisis in the eurozone retarded growth, but it did not completely derail development. China, entering the complex middle-income transition, experienced a bout of systemic risk associated with its leadership transition and a decade-long decline in reform momentum. That risk has declined with a successful leadership handoff and early signs of a forceful commitment to reduce corruption, alter the role of government in the growth model, and to deal with major social issues.
On the whole, the global economy, while not yet free of downside risk, appears set for a year of transition to better-balanced economic growth, albeit with lagging employment and income inequality continuing to hamper a robust recovery.
Europe’s challenge for 2013 will be sustaining support for economic reform, maintaining market confidence, and making progress on a banking and fiscal union. This will require, above all, growth. On this count, there is reason for pessimism.
The International Monetary Fund projects only 0.2 percent growth in Europe next year, and many private forecasters are more pessimistic. A weak global environment means exports may be less of a driver for growth than it was in 2012. Domestic demand has stalled and will continue to be damaged by planned fiscal consolidation and a weakened financial system that is hesitant to lend. The looming fiscal cliff in the United States, as well as growth uncertainties in Asia, add to the downside risks.
Against this backdrop, markets
, and politicians continue to operate on different timelines, with markets demanding quicker action than European policymakers have been willing to provide. More progress is needed on reducing debt in the eurozone periphery, but Germany is unwilling to address the problem before its September 2013 elections. Banking reform is similarly on a slow track: while an agreement has been struck on a single supervisory mechanism, it will not be implemented before 2014, and a full banking union remains a distant goal. Add in continuing concerns over a Greek exit from the EMU, uncertainty surrounding Italian elections, and growing opposition to reform throughout the periphery after years of deep recession, and you have a volatile mix.
In 2012, the ECB’s announcement of a new bond purchase facility, coupled with its liquidity policies, provided breathing space from the crisis. However, markets may not be so kind next year if growth falters, adjustment efforts in the periphery remain under pressure, and negotiations to strengthen the monetary union continue to move at a snail’s pace.
A return to growth would provide confidence that reform can be sustained, economic targets met, and debt levels will remain sustainable. Without it, we are likely to see Europe again at the brink.
Ever since the double-digit inflation problems of the 1970s, the U.S. Federal Reserve has reacted strongly to any sign of inflation and avoided policies that might lead to hyperinflation. This high degree of sensitivity to inflation appeared to work well in the period from 1984 to 2007, known as the Great Moderation. But when the Great Recession of 2007-2009 hit, worries about inflation put a constraint on the Fed’s ability to aggressively attack our unemployment problem. In retrospect, the Fed was too timid: with so much slack in the economy, worries about inflation were overblown, and a more aggressive response to the unemployment problem would have been possible.
One of the most important emerging trends in macroeconomic policy is the movement toward central bank operating procedures that are more tolerant of the temporary increases in inflation needed to effectively fight unemployment in deep recessions. The Fed’s recent announcement that it is willing to allow inflation to drift above its 2 percent target as it battles unemployment is an example of this change in thinking. That’s a big departure from the Fed’s previous policy, by which it appeared unwilling to allow the target inflation rate to be exceeded at all.
This reevaluation of monetary policy in light of the experience of the Great Recession is not limited to the United States. Bank of Canada Governor Mark Carney, for example, recently hinted that he may employ similar monetary policies when he takes over as governor of the Bank of England in July of 2013. While he will still have to convince others on the monetary policy committee to adopt his views, he was chosen to shake things up, and certainly brings a more dovish outlook to the policy table.
Will this spread to continental Europe as well? Because of the hyperinflation in Germany’s history, there is considerable resistance to lowering the European Central Bank’s guard against inflation. But if these policies work in the United States and the United Kingdom, as I believe they will, the spread of these new ideas to the ECB and beyond is inevitable.
The upcoming year will mark the turning point when 8 percent growth in China is viewed as a welcome norm rather than a disappointment. It will also signal when tensions between the United States and China shifted from recriminations over the value of the renminbi to the barriers inhibiting foreign investment.
Over the past year, markets were fixated on China’s economic slowdown given the unrealistic hope that continued double-digit growth might compensate for the problems afflicting the OECD economies. But slower growth will be good for China if it represents a more sustainable path. As a maturing economy, quality rather than quantity of growth is what now matters.
With slackened import demand in the United States and Europe, China’s already much reduced trade surplus will continue to decline. The renminbi is no longer significantly out of line, although the United States will probably be the last to acknowledge the new reality.
Currency wars will recede as the source of tension for the two countries, but circumstances will push them to battle over foreign investment and technology transfer policies. This is evident in the recent outcries over security risks as Chinese firms seek greater access to the U.S. market and U.S. firms are pressured to share valuable technologies as the price for accessing China’s market.
China is the center of an Asian production sharing network that brings in components from other countries for assembly with export of the final product to the West. But these are low paying assembly jobs, and the priority now is to develop more sophisticated product lines that can generate the better paying positions needed to sustain rapid growth.
Beijing believes that this needs to come through development of "indigenous" technology, as was the case with South Korea and Taiwan. This involves securing the technological expertise either from abroad or developing it locally with or without the involvement of foreign partners. Thus tensions over technology transfer and respect for intellectual property rights will likely dominate discussions between the United States and China this coming year even as the rhetoric over exchange rates moderates.
Given the incessant brinksmanship in Washington over the nation’s fiscal challenges it isn’t hard to be pessimistic about the U.S. economy’s prospects in 2013. Under any scenario a retrenching federal government will weigh heavily on growth. But assuming Congress and President Barack Obama do roughly the right thing and strike a deal on the fiscal cliff, the economy will be enjoying healthy growth by this time next year. Housing is set to kick into gear, businesses will invest and hire more aggressively, and consumers will spend with more gusto.
A housing renaissance is already underway. This may be hard to believe after the dizzying six-year long crash in home sales, construction and house prices. But housing turned up this year and it will take off in 2013. The logic behind this optimism is simple: owning a home has never been so affordable. House prices have been slashed by more than one third since the onset of the housing bust and mortgage rates have never been lower. The rent-buy decision is also a slam dunk in much of the country as rents continue to rise almost everywhere.
Significantly, U.S. companies lowered their cost structures during the recession, and profit margins have never been wider. Strong profits and low interest rates have allowed firms to substantially lighten their debts and generate a flood of cash. Businesses will soon realize that to keep their earnings and stock values healthy, they need to seek new growth opportunities.
Household finances are less uniformly rosy, but they, too, are much improved. Higher-income households have shed debt, and most have only fixed-rate mortgages that have been made cheaper through refinancing. Lower-income households still struggle to make mortgage and student loan payments, but across all households, the proportion of after-tax income needed to stay current on outstanding debt is approaching record lows. Households aren’t likely to ramp up borrowing anytime soon--and lenders are unlikely to give them the opportunity--but most consumers no longer have to curtail spending to manage their debts.
The U.S. economy is one piece of legislation away from a much brighter future.