Economic Recovery Expected to Creep Ahead in 2012 – Jan 2012
The U.S. economy appears to be gaining momentum coming out of a disappointing 2011. Real GDP is expected to show a better than 3% annualized growth rate in the fourth quarter, which is up from roughly 2% in the third quarter, and considerably stronger than the first half of 2011 when growth was closer to 1%. Additionally, growth estimates for 2012 are starting to be revised upward, and are now in the 2.5%-3.0% range. Reflecting the stronger economy, job growth is also starting to revive. In December, private payrolls grew by more than 200,000, and the unemployment rate has dropped for the fourth consecutive month, falling to 8.5%. For the year, companies added 1.6 million employees, the best year of job gains since 2006. One surprising area of strength is manufacturing, which has been steadily adding jobs for the last two years. Before the gains of the last two years, manufacturing sector payrolls shrank in every year going back to 1997.
Lest we sound too optimistic, economic problems still abound. At this point, aggregate demand is still too weak to justify a strong resurgence of hiring. While it is likely that job growth will strengthen in the first half of 2012, the improvement will be gradual as uncertainties continue to undermine business confidence. Put another way, we expect firms will typically continue to hire only on an as-needed basis, and not make bold hiring moves in an attempt to spur company growth. As a result, the unemployment rate is expected to remain stubbornly above 8% through 2012.
Europe has now been pushed into recession by a lingering debt crisis. However, U.S. stock prices, in spite of dramatic volatility, are little changed since Europe’s problems surfaced nearly two years ago. It is easy to construct dark scenarios in which Europe loses the political will to hold the Euro zone together in its current form, and its economy enters a deep recession with significant spillover affects on the U.S. and other global economies. But this seems like a less likely outcome as Europe’s leaders are showing greater determination to work through the current issues.
In addition, the U.S. Federal Reserve and other global central banks have teamed together with the European Central Bank to provide funds to the stressed banking system. To the relief of financial markets, these powerful central banks seem to be signaling that they will not allow a major bank to fail from a lack of liquidity.
If policymakers successfully stabilize financial markets, Europe’s downturn is expected to be relatively mild, lasting only through the middle of 2012, with real GDP in the euro zone falling no more than 2%.
In late December, lawmakers passed a two-month extension of the payroll tax cut while continuing to negotiate a yearlong extension. Though both sides appear to agree on a yearlong cut in principal, reaching a final agreement was again bogged down in partisan wrangling.
Reaching an agreement to extend the 2-percentage point payroll tax rate reduction enacted for 2011, and the emergency unemployment insurance program, will have a meaningful impact on 2012 economic performance. Together they will be worth close to 0.9 percentage point on 2012 GDP, but would also cost taxpayers nearly $175 billion.
Given the lackluster economic recovery, it seems likely that policymakers will come to some agreement, because not extending the payroll tax reduction will prove to be even more costly if the economy slips back into recession.
With the heightened political and economic uncertainty,it is hard to see businesses expanding operations more aggressively through increasing investment or hiring anytime soon. Still, businesses have the financial wherewithal to do so—profits are strong and balance sheets are sturdy—but caution is still being practiced in the wake of the Great Recession, and events in Washington and Europe do little to bolster confidence.
Historically, economic recoveries have evolved into selfsustaining economic expansions when businesses decided to take a leap of faith and expand without knowing for sure whether demand justified the additional production.
The current business cycle appeared to be following a similar pattern early in 2011, as firms began to increase investment and hiring. But this was apparently short-circuited by a surge in commodity prices, the Japanese disaster, the spectacle in Washington over the debt ceiling, and the European debt crisis. How long it will take to get the business cycle back into gear isn’t yet apparent, but it is possible that business investment and hiring will remain sluggish until after the 2012 election.
With businesses expected to remain cautious, 2012 is unlikely to be a breakout year for the U.S. economy. That said, real GDP is expected to post respectable growth in the range of 2.5%-3.0%, while creating as many as two million new jobs. However, the unemployment rate is likely to remain above 8%.
With modest growth and stubbornly high unemployment, inflation and interest rates are expected to remain low. Core consumer price inflation will stay well below the Federal Reserve’s implicit 2% target, which should allow the Fed to easily continue its zero-interest rate policy.
