In addition to a host of warnings, last Wednesday’s Congressional Budget Office report did contain a little bit of good news. The economy will grow slightly faster in the second half of 2012 than in the first half, and inflation will stay extremely low, according to projections in the CBO’s Update to the Budget and Economic Outlook. The bad news is that unemployment will probably remain above 8%. The worse news is that next year the U.S. faces continued high unemployment, below-average growth and the risk of a double-dip recession.
The U.S. economy never built up much of a head of steam coming out of the 2007-09 recession, which saw the biggest drop in real GDP since the 1940s and the highest unemployment since the early 1980s. Historically, after such a major downturn ends, there’s typically a powerful rebound in which real GDP growth averages more than 4.5% annually over a period of two or three years and briefly hits annualized rates above 9%. By contrast, during the recovery that began in 2009, the economy has never grown faster than 4.5% and has averaged about 2.2% a year.
And next year, the global economic situation figures to be even less hospitable to growth, which will make it harder for the U.S. economy to speed up from its current disappointing pace. Indeed, last week the ratings agency Standard & Poor’s released a report saying that the chances of a recession in the U.S. in 2013 had increased to 25%, up from 20% in February. A U.S. recession is by no means inevitable, but the domestic economy faces three large hurdles, any one of which could mean the difference between steady growth and another economic contraction.
The fiscal cliff. Under current law, a variety of tax increases and spending cuts are scheduled to go into effect next year, with serious consequences. On the plus side, these measures would cut the deficit by more than $500 billion. The Federal debt, as a percentage of GDP, would slowly begin to shrink. All that deficit reduction, however, would come at the price of a likely reduction in the economy’s output of more than two percentage points, resulting in a mild-to-moderate recession. That’s just one of the reasons why these policies aren’t likely to go into effect as they stand. A gridlocked Congress and a closely-contested Presidential election make any sort of legislative action unlikely before November. But neither party wants to allow tax cuts to expire for the middle-class or to see more people get hit with the alternative minimum tax. And while the parties disagree on reductions in defense spending and Medicare payments to doctors, the cuts currently scheduled are so large that they will probably be modified or delayed. Historically, Congress has been very good at avoiding big middle-class tax increases and sudden, disruptive spending cuts. While the fiscal cliff may not be eliminated entirely, odds are it will be greatly reduced – even if only at the last possible moment.
The global slowdown. While the U.S. economy is growing, albeit somewhat sluggishly, growth around the rest of the world is slowing. Several European countries are already in recession, and the continent as a whole is heading in that direction. Indeed, recent figures show that the private sector in the euro zone has been contracting for seven months. Even Germany’s economy is losing momentum, and current trends indicate that real GDP for the overall euro zone could fall by half a percentage point in the current quarter. Moreover, if there is some sort of euro currency crisis, the resulting shocks to major European banks could turn a minor slowdown into a severe and possibly worldwide recession. In addition, the U.K. has been in recession since late 2011. And some booming economies in the rest of the world – like China and Brazil – are looking at significantly slower growth, dashing the hopes of some that growth in newly advanced economies would blunt the impact of a recession in the developed world.
The stimulus shortfall. Ordinarily, in a situation like this the Federal government would try to rev up the U.S. economy with fiscal and monetary stimulus. Only trouble is, the emergency fuel tank is empty. Over the past 12 years, taxes have been cut and kept low, government spending has ratcheted up, the Federal Reserve has cut short-term interest rates to a minimum and has even taken to stoking the money supply through a process known as quantitative easing (which amounts to creating money by purchasing government bonds). With yearly deficits topping $1 trillion, there is little appetite in Washington for further fiscal stimulus, either through tax cuts or spending. On the monetary side of things, the Fed can’t push interest rates much lower, and the impact of another round of quantitative easing is unlikely to last any longer than the effects of the previous two rounds.
None of this means that a U.S. recession is inevitable. Sure, a mild slump in Europe, combined with slower growth in places like China, would affect U.S. multinationals that sell a lot overseas. And a financial crisis in the euro zone would doubtless hurt U.S. banks to some extent. But U.S. GDP growth depends largely on domestic factors, and there is still time for Congress to resolve the looming fiscal-cliff issues in a way that prevents a sudden shock to the economy and reduces the risk of another recession.
But while the private and public sectors in the U.S. have the wherewithal to avoid contracting GDP, that doesn’t mean that we’ll see the kind of growth that will put a serious dent in the unemployment rate. Even under the CBO’s optimistic scenario, real-GDP growth will pick up only from 1.75% at an annual rate to 2.25% later this year, and average 1.7% in 2013. Having failed to rebound when the weather was more favorable, the U.S. economy is hardly likely to do any better as storm clouds start rolling in.