The Current State of Economy

Heyward Yarborough
February 18, 2013
Essentials of Personal Finance (FP/120)

Current State of Economy: In the year 2013

Now that the fiscal cliff fight is over and the debt ceiling debate hasn’t reached a fever pitch — not yet, anyway — it seems like a good time to take a step back, assess the economic outlook, and see what it means for American families. The good news is that the U.S. has enjoyed more than three years of uninterrupted economic growth and falling unemployment since the recession ended. The bad news is that this has been the weakest rebound since World War II. Economic growth has averaged less than 2.25% since the recovery began and is estimated to have slowed to less than 1% in the most recent quarter. Unemployment is still way above where it should be at this point.

Budget problems remain the chief impediment to faster growth. The fiscal cliff deal did little to reduce the annual deficit, almost $1.1 trillion last year. Not that entire amount needs to be eliminated, though. Part of the current deficit is simply the normal result of a weak economy. Moreover, if the economy were growing at its historical average rate of 3.25% a year, the U.S. could afford to run a deficit of half a trillion dollars or so. Even so, the deficit still needs to be reduced by something like $300 billion a year. That means further spending cuts and tax hikes that will be a drag on the economy.

Consensus estimates are for slightly slower growth this year – an estimated 1.8%, down from 2.2% in 2012. The most optimistic economists foresee a small improvement in growth this year, followed by 3% or more in 2014. While that would get the economy back to its long-term average growth rate, it would remain far short of the powerful rebound that normally follows a recession.

For the past three years, unemployment has been coming down slowly but steadily. The most recent report calculated that 155,000 jobs were added to the U.S. economy in December and that the unemployment rate of 7.8% was unchanged from the revised figure for November. Significantly faster job creation – 300,000 or more new jobs a month – would be needed to bring unemployment down with the speed desired.

While the fiscal cliff debate centered on tax hikes for the rich, the expiration of the payroll tax cut means that most middle-class families are paying $600 to $1,200 more a year. With both the debt ceiling and the sequester approaching, additional revenues will probably have to be raised as part of any bargain to cut spending and reduce the deficit. Any tax rate increases or caps on deductions will doubtless be aimed at the rich, but typical families will probably be hit to some degree as well.

Policy makers can relax when annual inflation is between zero and 2%, and right now they’re enjoying sweet repose. Consumer prices have risen only 1.8% over the past 12 months. Indeed, this past summer Federal Reserve chairman Ben Bernanke rated his policy of quantitative easing as pretty much a total success. Only trouble is, Bernanke has tripled the size of the money supply in the process, which could spur inflation if the economy ever starts growing robustly.

Consumers remain cautious, and credit-card debt is down 16.5% since it peaked before the recession. That will enable families to step up their spending a little as the economy improves. Certain specific categories of debt, however, are still rising. In particular, big student loans are weighing on recent college graduates who have not yet been able to find well-paying jobs.

The real estate market continues to move up, and further improvement is likely as unemployment comes down. But home prices remain far below their previous highs. Moreover, there is still an overhang of distressed and previously foreclosed properties for sale that will hold back a broad housing market recovery.

Although gas prices fell late last year, they have started back up again, thanks in part to steeper taxes. Overall, they remain quite high by historical standards. Ultimately, gas prices depend on the cost of oil, which has more than doubled since the recession ended. As the global economy recovers, demand for oil could increase, which would keep gas prices high.

The combination of slow growth and low inflation is generally good for stocks, and a number of forecasters see moderate gains for blue chips this year – including Jeremy Siegel, who has said “there is an overwhelming probability that we’re going to get Dow 15,000.” Certainly it makes sense for investors to continue making contributions to their long-term retirement plans. Unfortunately, the current job market is forcing some families to borrow against their 401(k) savings.

Overall, the economy is slowly improving, although it could be derailed by unexpected shocks. In addition to domestic problems, there are the same international risks that have existed for more than a year. Conflict with Iran could push up oil prices. Economic turmoil in China could disrupt the global economy. And the euro currency crisis – which continues to worsen despite sporadic upbeat declarations – could hurt growth worldwide.

For people who have secure jobs, good credit, and a stable housing situation, the outlook is generally encouraging. Taxes, inflation, and gas prices may creep up but higher stock prices and home values matter a lot more. The discouraging note is that this recovery will most likely continue to be weak. That won’t do much to help those who are unemployed or underemployed, or who have lost their homes. Addressing those problems would require far more ambitious budget reforms than have been considered to date. And without such reforms, the great danger is that current slow growth.