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Looking at US economy 2012

A.R. Chowdhury
IT may not be obvious, but the US economy has been getting better. After a fairly miserable first half of the year, the economy grew by 2% in the third quarter and is likely to accelerate to more than 3% growth in the final quarter of 2011. While there are a number of signs that recent momentum could carry into next year — job openings are on the rise, the unemployment rate is trending down and corporate profits relative to GDP are at their highest level in over six decades — the economy does not operate in isolation. There are two major risks to the US outlook: the expanding financial crisis in Europe and fiscal restraint from Capitol Hill in Washington. On both fronts, the risks have intensified in the last few months.
Despite the uncertainties, growth has picked up recently. Auto output and sales have rebounded as Japanese supply lines have reopened and production increased. Earlier weather disruptions have eased and the partial reversal of oil price spikes has helped discretionary income. Consumer spending is rising at the fastest rate in a year and business spending on equipment is growing at doubledigits.
The financial supports for growth are improving slowly but overall conditions still represent a modest risk for the economy. Bank credit is rising again, led by a growth in business lending, while consumer credit card limits are edging up. However, financial stress indicators are elevated and contagion from the European sovereign debt crisis could feed through the banking system. Volatile markets caution that investors lack confidence in policymakers' abilities to head off contagion.
The lack of any revival in housing remains the key shortfall in the broader recovery and prospects favour very modest gains in homebuilding. Although home prices have steadied in many parts of the country, vacancies and inventories are high, while more than a quarter of mortgages are under water.
The relative weakness in construction and finance along with ongoing retrenchment in the state and local
sectors has contributed to slow employment gains and we expect the jobless rate to decline very little in 2012. Although the recovery has netted 2.3 million new jobs since early 2010, the employment-population ratio is near a 30-year low and there are four unemployed workers for each job opening. Despite strong profits and historically-wide margins that
typically have signaled strong labour markets, policy uncertainties may be exacerbating firms' reluctance to expand.
Recent signs of easing price pressures will continue in 2012. Core inflation has been below 2% for sometime now. Earlier factory bottlenecks have loosened; pipeline prices have
declined; unit labour costs have stopped falling but wage growth remains modest and consumers have resisted business attempts to flex new pricing power.
Monetary policy is expected to remain focused on supporting financial conditions throughout 2012. With inflation within desired ranges and unemployment stubbornly high, we
do not expect federal funds rates to rise until sometime beyond 2013. Recent easing moves have had favourable effects, but financial conditions remain weaker than normal. Fed officials have kept the door open to expanding the balance sheet again but their likely first option will be to use communications strategies to
extend accommodation.
A major impediment to US growth over the next few years will be fiscal restraint. The Congress has just extended last year's payroll tax cut and emergency unemployment benefits for two months. If these measures are allowed to expire in February 2012, this would reduce economic growth by at least 0.5 percentage points in 2012 with the bulk of the impact absorbed in the first half of the year. We expect policymakers to come to an agreement to extend the tax cut. But there are considerable risks surrounding this expectation.
The risks to the outlook from fiscal policy do not end there. The failure to reach an agreement in February means that under current law, steep automatic spending cuts are scheduled for January 2013. While the automatic spending caps will likely be reversed or replaced with less front-loaded cuts before they come into effect, the mere anticipation of the cuts is likely to make some reductions in government spending unavoidable. This headwind, in combination with spending cuts as part of the debt-ceiling deal, reductions in infrastructure spending and declines in state and local government aid will likely reduce economic growth by 0.5 percentage points in 2012.
While gridlock is likely to continue to characterise the US political scene over the next year, the election in late 2012 may serve as a catalyst for more decisive post-election action on some of the outstanding fiscal questions facing the economy. The bottom line is that fiscal policy is likely to be a drag on economic growth for many years to come. And, while the federal government absolutely needs to address its long term deficit issues, there is a risk that they will cut spending too much and too soon, sucking demand out of the economy at a time when the private sector is still finding its feet.
All told, the US economy continues to grow, and has even shown some encouraging resilience over the last few months. Still, while progress has been made, pitfalls con->tinue to mark the road to recovery.
The writer is Professor and Chair, Department of Economics, Marquette University and Advisor, Federal Reserve Bank.