Tuesday, January 17, 2012


Slowing growth amid greater uncertainty and fiscal consolidation 

Weak private consumption and fiscal policies  depress growth
The  outlook for the US economy has worsened  considerably compared to the spring forecast.  Real GDP growth  decelerated from 0.8% q-o-q  in the  fourth quarter of 2010 to a mere 0.1% and 0.3% in the first and second quarter of 2011, the weakest  growth since the first half of 2009. The slowdown largely reflected weak private consumption coupled with an increasingly negative impulse from the fiscal side. Some temporary factors  weighed on activity in the first half of 2011. High commodity prices combined with supply-chain  disruptions relating to the Japanese tsunami disaster constrained output across the economy and  deferred corporate employment and investment decisions despite buoyant profits.
Private consumption slowed sharply from a robust  0.9% q-o-q in Q4-2010, down to 0.3% and 0.5% in the first and second quarter of 2011. Households have  borne the brunt of peaking oil prices and  stagnation in the labour market, where improving trends from 2010 and early 2011 have stalled  leaving unemployment above 9% amid the lowest activity rates since the early 1980s. Confidence  and wealth were further depressed by a series of stock market declines that wiped out most of the gains from the 2010 equity rally and led consumers to further curtail spending. 
Private capital formation fared better, supported by robust corporate investment in equipment, software and structures in selected industries (e.g. mining). Investment benefited from  robust corporate balance sheets and the low cost of capital  but has become increasingly thwarted by rising  uncertainty regarding the economic outlook. The housing market remained subdued in 2011 and most indicators suggest that it has not bottomed out yet. New residential construction stabilised at a low level but the large supply of existing homes coupled with weak demand is putting downward pressure on prices. House price indices declined in the first quarter of 2011 and have remained flat since then.

Fiscal contraction vs. loose monetary policy
The gradual phasing out of crisis stimulus packages as well as shrinking public consumption and investment resulted in a fiscal contraction in the first half of 2011. By contrast, monetary policy remained accommodative with the Fed committing to keep policy interest rates at historically low levels (0% to ¼%) at least until mid-2013.
Furthermore, during its September meeting the Fed decided to extend  the average maturity of its holdings of  securities  so as to  put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative ('Operation Twist').
Labour market improvements, still tentative at the turn of 2010, have stalled. After falling to 8.8% in March 2011 the unemployment rate rebounded above 9% in April and has remained there since then. Persistently weak labour demand led to the lengthening of unemployment duration, increased exits from the labour force and depressed activity rates. High commodity prices (predominately oil and food) pushed consumer price inflation up to its pre-crisis level (3.9% y-o-y in September 2011). At roughly half the rate of headline inflation, core inflation has been accelerating as well to reach 2% in August (up by 1 pp. from January), suggesting significant pass-through of supply shocks to core prices.

Slow growth scenario
Real GDP is expected to rebound from the exceptionally sluggish growth in the first  half of 2011, but the overall outlook for the coming years has deteriorated considerably compared to the spring forecast. Real GDP growth is expected todecelerate from 1.6% in 2011 to 1.5% in 2012 and 1.3% in 2013, largely reflecting the negative impact of fiscal policies combined with slack private demand, weakened by domestic and global uncertainties. 
Private consumption, which accounts for almost 70% of US GDP,  is predicted to remain sluggish over the forecast horizon. Weak employment prospects coupled with a contractionary fiscal environment (particularly in 2013) will generally restrain spending, as will the feeble situation in the housing market and the ongoing process of deleveraging. While households have made great progress in deleveraging in recent years (see graph below), the process is likely to continue over the forecast horizon, limiting the chances of robust credit-led spending growth.

Grim labour market outlook delays recovery
The labour market outlook is expected to remain challenging, reflecting high unemployment combined with declining activity rates. The share of long-term unemployed (27 weeks +) in the total number of unemployed has registered historical highs (above 40% since early 2010 compared to 10% in the 1990s), pointing to new labour market and social challenges emerging in the US. These negative trends limit prospects for a major decline in the number of unemployed over the forecast horizon. The unemployment rate is expected to remain at around 9% until 2013.
Gross fixed capital formation is expected to regain some strength in line with rebounding corporate investment. We expect confidence to improve gradually  over the forecast horizon under the assumption of a resolution to the European debt crisis and the emergence of a convincing plan formedium-term fiscal consolidation in the US. This should lead corporations to intensify investment particularly in areas neglected in the past couple of years (e.g. structures, transportation equipment).
Private residential investment has yet to bottom out as the persistently difficult labour market situation limits the scope for a rebound in the short term. At present, a flat supply of new homes meets a rising number of existing homes on sale. The resulting downward pressure on prices  further worsens the position of homeowners , leading to more mortgage defaults via a feedback loop. This situation is expected to ease in the course of 2012 and trigger a very subdued and gradual recovery of house prices and, subsequently, of residential investment.

Uncertain profile of fiscal consolidation
Fiscal policy is set to exert an increasing drag on economic growth over the forecast horizon.  On 2 August President Obama signed  the Budget Control Act of 2011 (BCA) which cuts federal spending over  the  next 10 years in exchange for raising the debt ceiling. The act imposes budget cuts  amounting to  at least USD  2.1 trillion until 2021. Out of this amount USD  0.9 trillion will come from agreed caps on discretionary spending while an additional USD 1.2 trillion is to be found by 23 November by the bipartisan Congressional Committee for Deficit Reduction (CCDR). If the Committee fails to reach an agreement,  broadbased spending cuts are to be applied automatically from 2013 of an amount equal to the difference between the agreed savings and the USD 1.2 trillion target.
The  BCA sets the US on a path of steady consolidation that is designed to be front-loaded in 2012 and 2013, with deficit reduction equivalent to 2.3% and 3% of GDP in both years. This results from the BCA-agreed spending cuts coupled with the scheduled expiration of the 2010 payroll tax cuts and unemployment benefits, the expiration of the 2001 and 2003 Bush tax cuts as well as the ongoing effect of  crisis-linked stimulus and other programmes coming to an end. 
However, the amount of actual fiscal  tightening over the forecast horizon is likely to be lower than implied by the current law, due to a number of recent initiatives aimed at easing the major fiscal drag ahead. This forecast assumes  that: (i) the least disputed tax-cuts-related part of the USD 447 bn  American Jobs Act proposed by President Obama in early September will be enacted into law generating a positive fiscal impulse of around 1% of GDP; (ii) the Bush tax cuts set to expire in 2012 are likely to be partially extended, thus easing the 2013 consolidation by around 1% of GDP. The extent of fiscal restraint in 2013 is unclear, due to the unknown outcome of the Committee's negotiations at the time of publication, as well as to the number of policy options currently discussed in Congress. 

Risks tilted to the downside
The risks to the outlook are  clearly  tilted to the downside.  Fiscal policy will remain a source of
uncertainty as the design of medium-term fiscal consolidation is complicated by the weak economic outlook and a political gridlock ahead of the presidential elections. Should the consolidation plan to emerge from the current debate be insufficiently ambitious or credible for financial markets, this would undermine already weak business and household confidence.  Resumingstock market declines  triggered by  any unfavourable policy developments domestically or internationally  could further  harm consumer confidence and discourage spending, putting the modest growth scenario at risk.

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