United States: Working toward a recovery that can stand on its own

United States: Working toward a recovery that can stand on its own

United States: Working toward a recovery that can stand on its own

Global Economic Outlook Q3 2013

The United States will likely experience slow-to-moderate economic growth for the rest of the year. Anemic economic expansion in 2013 may set the stage for a stronger performance in 2014.

GEO Q3 United States

The path that will transform a currently anemic economic expansion into a more robust recovery has been bumpy, but the United States continues to make progress.

The unwelcome news that the United States only grew by 1.8 percent in the first quarter of 2013, rather than the 2.4 percent growth that was previously estimated, is a reminder that 2013 is a year of transition. We do not expect sustained higher growth levels until 2014, as the economy needs time to adjust to the tax increases that went into effect at the beginning of the year and the cuts in federal spending that began in March. However, even with these challenges, the outlook for the United States has improved to the point where attention is now on the timing of Federal Reserve’s reduction and discontinuation of asset purchases and its plan for interest rates to rise to more normal levels.

A weaker start to the year

Based on new and revised data, the estimate of first quarter GDP was adjusted sharply downward in June as estimates for growth in consumer spending, business investment, imports, and exports were reduced (see figure 1). The largest downward revision was in consumer spending, where the revisions were concentrated in service purchases—especially legal services, personal care services, and health care spending. The estimate for the contribution from consumer spending on goods actually increased. Another sizable change was the downward revision to fixed business investment that was primarily accounted for by a larger decline in investment in structures; the contribution from equipment and software held steady, albeit at a low level.

Figure 1. Contributions to percent change in first quarter real GDPChange from 2nd estimate to 3rd estimate

Unintended turmoil from the Fed

For the remainder of the year, the United States should continue to experience slow-to-moderate growth with a slowly improving employment situation, setting the stage for a stronger 2014.

Given the continued improvement in the economy, the Federal Open Market Committee (FOMC) of the Federal Reserve Board (FED) signaled in May and again in June that if unemployment continues to fall, it will consider whether to begin to decrease the rate of asset purchases (known as QE3), which is currently running at $85 billion per month. The FOMC also stated that if conditions began to deteriorate, it would consider increasing asset purchases. Neither of these statements reflected a change in policy, but some market analysts reacted as if the FOMC was about to cease all asset purchases and raise the federal funds rate target in the near future, and the stock and bond markets went on a roller coaster ride.

Asset purchases were never intended to be an ongoing feature of monetary policy, and eventually—most likely over a period of years—the Fed will begin to reduce its balance sheet to levels more in line with historical levels.

In order to clarify the FOMC position, Chairman Bernanke gave a press conference on June 19 where he stressed the following points:

  • The Fed has three tools that it is currently using to “support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate:”
    • Setting the target federal funds rate at 0.0–0.25 percent to foster low near-term interest rates
    • Communicating that it plans to keep the target very low during the midterm
    • Stimulating prices by purchasing Treasuries at the rate of $45 billion per month and purchasing agency mortgage-backed securities at the rate of $40 billion per month. The rate of asset purchases can be reduced or increased as conditions warrant.
  • When considering the individual economic forecasts of the members of the FOMC, it is conceivable that unemployment could fall to 7.0 percent by the end of this year. If this were to occur, the FOMC would consider whether it should slow the rate of asset purchases.
  • When unemployment reaches 6.5 percent, the FOMC will consider whether to discontinue further asset purchases and will look for signs of strength that would cause the committee to consider a gradual increase in the federal funds rate.

It was clear that Bernanke was not setting a timeline and that he was discussing thresholds where changes should be considered in light of current economic conditions, not triggers that would result in automatic changes in policy.

Prior to a financial crisis that nearly resulted in financial collapse, the Fed maintained a balance sheet that grew slowly over time. All of that changed in October 2008 when the Treasury and Fed began to pull every lever at their disposal, as well as create new ones, in order to shore up the financial system. In a bid to provide liquidity, the Fed began to rapidly expand its balance sheet. As seen in figure 2, this shift was large and rapid. Between the end of October and the end of November 2008, the Fed’s balance sheet expanded by a third. Just prior to the beginning of the latest round of asset purchases in September 2012, the Fed’s balance sheet tripled in size from its pre-crisis level. Recognizing that the Congress and the Administration were not going to act to speed the recovery, the Fed embarked on its latest round of asset purchases. As of June 2013, QE3 has resulted in an additional 23 percent increase in the Fed’s balance sheet.

Figure 2: Total Federal Reserve Board assets

As the Fed sees the economy strengthen, it will taper off purchases of new assets. Asset purchases were never intended to be an ongoing feature of monetary policy, and eventually—most likely over a period of years—the Fed will begin to reduce its balance sheet to levels more in line with historical levels. The stock of assets is itself stimulative, holding up prices of Treasuries and mortgage-backed securities by reducing the supply. When growth strengthens sufficiently, the Fed’s focus will shift; when growth strengthens sufficiently, the Fed’s focus will shift to maintaining price stability, and interest rates will be allowed to rise from their current exceptionally low levels. The FOMC is extremely mindful that all these adjustment will need to be done gradually, with a close eye on economic conditions.

Fiscal policy: Cost with little benefit

There is little doubt that the disappointing growth experienced in the first quarter of the year is, at least partially, attributable to the expiration of certain tax policies, most notably the temporary two percentage point reduction in payroll tax and the Bush tax cuts for high income earners. The automatic spending cuts that took effect in March will provide further drag for the remainder of the year. The Congressional Budget Office estimates that these two policy moves will reduce real GDP growth by about 1.25 percent this year. So what did we get in return for this lower rate of growth?

  • A lower deficit this year: For fiscal year 2013 as a whole, CBO now estimates that the budget deficit will shrink to $642 billion, the smallest shortfall since 2008. Relative to the size of the economy, at 4.0 percent of GDP, the deficit this year will be less than half as large as the shortfall in 2009, which was 10.1 percent of GDP. However, only part of this is attributable to higher tax rates; higher employment and an increase in payments to the Treasury by Fannie Mae and Freddie Mac were also major contributors.
  • A lower deficit over the next two years: Because revenues are projected to rise more rapidly than spending in the next two years, CBO projects that annual deficits will continue to shrink, falling to 2.1 percent of GDP by 2015. Stronger growth might have approached a similar result.
  • But no real fix for our long-term problems, as an aging population and rising health care costs will cause the deficit as a percent of GDP to rise again.

It is difficult to see how this Congress and the Administration can work together to make the hard choices necessary to provide long-term solutions, but we do know that the longer they wait, the harder the fix will be.


Dr. Patricia Buckley

Dr. Patricia Buckley is a director of Economic Policy and Analysis at Deloitte Research, Deloitte Services LP.

Global Economic Outlook, Q3 2013: United States
Cover Image by Jessica McCourt