Cliff averted, but... Economics weekly


Cliff averted, but... Economics weekly

A new year, and the fact you're reading this is evidence that the world hasn't imploded. The US economy wasn’t driven off a fiscal cliff and indications suggest stronger growth in UK bank lending

Economic Analysis

07 January 2013

But as everyone knows, a new year doesn't magically make old troubles disappear. February sees the start of the Chinese New Year. Fittingly it's the year of the snake and there’s plenty that could bite. First, the (fiscal) cliff may have been navigated, but just like Bilbo, President Obama still has to lead the US economy on a treacherous journey over debt mountains and spending-cut gorges. Additionally, UK public borrowing remains perilously high, while the eurozone economy looks worryingly weak. So a Happy New Year. But for the economy and for us all, it’s back to the grind.

Fiscal cliff (partly) averted

The $655bn game of brinkmanship has been brought to a partial close with an agreement preventing certain taxes from rising, sucking $212bn out of households’ budgets in 2013. The equivalent of $2,200 for a family of four. See US fiscal cliff deal for further comment. But policy-makers are giving with one hand and taking with another. The expiry of a separate temporary reduction in payroll taxes will actually leave 77% of households with a higher tax bill in 2013 according to one Washington think-tank.

In fact, the level of fiscal tightening in the US this year will be higher than anything the UK has experienced since beginning its budget deficit reduction efforts. The US has a bit of ‘gas in the tank’ with growth ticking along at a reasonable pace but the economy is far from immune to cuts of this size.

But ‘three gorges’ loom

The deal on taxes is only part of the story. Congress now faces a fraught couple of months. There are three main obstacles to overcome: the debt ceiling at the end of February; the automatic defence and welfare cuts in early March; and the need to renew the US government’s permission to spend any money at all by 23 March. The cliff may be in the rear-view mirror, but ‘three gorges’ lie ahead.

US central bankers divided on quantitative easing

2012 saw the US Fed making some bold changes to how it conducts monetary policy, mainly by linking policy decisions directly to the performance of the labour market. Rather than set an end date to its latest quantitative easing (QE) programme, the Fed said it would continue until there was “substantial improvement in the labour market.”

But the minutes from the December meeting suggest the committee is not united. “Several” members suggested asset purchases may need to be halted before the end of 2013, rather than wait for the labour market to improve. But with unemployment remaining elevated, a halt to QE is unlikely in the near-term.

UK: working more, doing less

A persistent theme of the post-crisis UK economy has been surprisingly strong employment gains in the face of weak GDP growth. As a result productivity has nose-dived. Current output per hour worked in the UK private sector was last this low in Q1 2005 and is nearly 4% below Q3 2011’s level. The upshot for the economy is clear. Firms are unlikely to grant generous wage rises if their employees aren’t producing more.

UK borrowing higher, but one-off effects to help in 2013

Public sector borrowing came in at £17.5bn in November, around £1.2bn higher than November 2011, as government spending rose. The public finances continue to disappoint with the deficit £8.3bn higher than this time last year. Coupon payments from QE and revenues from the 4G auction will help to tame borrowing in the remainder of the fiscal year. These are a welcome helping hand but won’t  provide permanent support to the public purse. March’s budget may have to include more difficult choices.

The eurozone and the UK enter 2013 with little by way of economic momentum

The eurozone’s composite Purchasing Managers' Index, covering both manufacturers and service providers, delivered a reading of 47.2 in December. It was the 11th straight month of a sub-50 reading, indicating contraction. In the UK, manufacturing jumped to 51.4, the highest reading since February. But services sank to 48.9, the lowest reading since April 2009, apart from December 2010’s snow-related contraction. A reduction in new business was the culprit as economic uncertainty continues.

Japan's central bank could be set for a radical change

To help tackle the economy's persistent deflation, Japan's new prime minister wants the central bank to bump its inflation "goal" to 2% and may force them if they fail to cooperate. He has also floated the idea of the Bank of Japan purchasing construction bonds – government debt issued to fund public works – in unlimited quantities. Such deficit financing is hugely controversial and would mark a radical departure from the accepted orthodoxy of central bank independence that has been a pillar of economic thinking for the past two decades.

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