1. The U.S. recovery has remained tepid over the past year, but underlying fundamentals have been gradually improving. The modest growth rate of 2.2 percent in 2012 reflected legacy effects from the financial crisis, fiscal deficit reduction, a weak external environment, and temporary effects of extreme weather-related events. These headwinds notwithstanding, the nature of the recovery appears to be changing. In particular, house prices and construction activity have rebounded, household balance sheets have strengthened, labor market conditions have improved, and corporate profitability and balance sheets remain strong, especially for large firms. With the sizeable output gap and well-anchored inflation expectations keeping inflation subdued, the Fed appropriately continued to add monetary policy accommodation over the past year by increasing its asset purchases and linking the path of short-term rates to quantitative measures of economic performance, thus helping to maintain long-term rates at exceptionally low levels.
2. However, growth is expected to slow to 1.9 percent this year owing to an excessively rapid pace of fiscal deficit reduction, before accelerating to 2.7 percent next year.
The general government deficit will decline by over 2½ percent, subtracting between 1¼–1¾ percentage points from growth in 2013, the debt ceiling will be raised without any disruption to the U.S. and the global economy, and the Fed will continue asset purchases until the end of this year. The unemployment rate is projected to remain around 7½ percent throughout 2013. Employment growth is projected to pick up late this year and in 2014, fostered by an acceleration of output growth. With labor force participation projected to recover somewhat in 2014 as discouraged workers return to the labor force, the unemployment rate is projected to decrease (on average) to 7.2 percent next year.
Given the wide output gap, inflation is expected to remain relatively subdued over this year and the next. As the legacy of the financial crisis wanes further, private domestic demand is expected to continue recovering, but weak growth in a number of trading partners is projected to weigh on export growth.
2. However, growth is expected to slow to 1.9 percent this year owing to an excessively rapid pace of fiscal deficit reduction, before accelerating to 2.7 percent next year.
The general government deficit will decline by over 2½ percent, subtracting between 1¼–1¾ percentage points from growth in 2013, the debt ceiling will be raised without any disruption to the U.S. and the global economy, and the Fed will continue asset purchases until the end of this year. The unemployment rate is projected to remain around 7½ percent throughout 2013. Employment growth is projected to pick up late this year and in 2014, fostered by an acceleration of output growth. With labor force participation projected to recover somewhat in 2014 as discouraged workers return to the labor force, the unemployment rate is projected to decrease (on average) to 7.2 percent next year.
Given the wide output gap, inflation is expected to remain relatively subdued over this year and the next. As the legacy of the financial crisis wanes further, private domestic demand is expected to continue recovering, but weak growth in a number of trading partners is projected to weigh on export growth.
3. Risks to the outlook appear modestly tilted to the downside.
• A stronger impact of fiscal consolidation, a weaker external environment, and higher structural unemployment are the main downside risks.
While private consumption has so far weathered relatively well both higher tax rates and the spending cuts from the “sequester”, both measures might prove to be a stronger headwind to consumer demand over the next few quarters. A slower pace of recovery may in turn delay the normalization of labor market conditions and reduce long-term growth.
External demand may also be held back by a slower pick-up in global economic activity reflecting lower growth in a number of emerging market economies.
While private consumption has so far weathered relatively well both higher tax rates and the spending cuts from the “sequester”, both measures might prove to be a stronger headwind to consumer demand over the next few quarters. A slower pace of recovery may in turn delay the normalization of labor market conditions and reduce long-term growth.
External demand may also be held back by a slower pick-up in global economic activity reflecting lower growth in a number of emerging market economies.
