ALMOST every year since the end of the financial crisis has started with rosy expectations among American forecasters, and this one is no different. Stockmarkets are buoyant, consumer confidence is improving, and economic seers are raising their growth forecasts for 2014. America’s S&P 500 share index is at a record high, after rising 30% in 2013—the biggest annual gain in almost two decades. Powered by America, global growth of close to 4%, on a purchasing-power-parity basis, seems possible. That would be nearly a full percentage point faster than 2013, and the best showing for several years.
Yet amid the new-year cheer, it is worth remembering that almost every year since the financial crisis upbeat expectations have been disappointed. The biggest danger this time round is the optimism itself.
Fiscal ease
All around the rich world, things are looking better. Britain’s recovery is gathering pace (see article). Japan’s economy seems strong enough to cope with the imminent rise in its consumption tax. Even Europe’s prospects are less dismal. But America is driving this recovery.
America’s growth rests on strong foundations. First, household and corporate balance-sheets are in good shape. Unlike Europeans, who have barely reduced their private debt, Americans have put the hangover from the financial crisis behind them. The revival in house prices is testament to that. Second, thanks to cheap energy, years of wage restraint and a relatively weak dollar, America is competitive. These two factors have combined to produce faster job growth which, along with higher share prices, suggests stronger consumer spending and higher investment ahead. Finally, the fiscal squeeze is abating. In 2013 the federal government took 1.75% of GDP out of the economy with tax rises and spending cuts. The recently agreed budget deal will help cut the fiscal squeeze to 0.5% of GDP this year. All these factors could boost America’s growth to around 3% in 2014, well above its trend rate.
More spending by American firms and households will, in turn, buoy demand for goods and services from everywhere from China to Germany. America’s appetite for foreign wares is not what it once was (the current-account deficit has fallen to a 15-year low of 2.2% of GDP, see article), but its economy is so big that faster spending will push up exports around the globe. The resulting support for growth will, in turn, improve domestic confidence from Europe to Japan.
The trouble is that trade channels are not the only, or even the main, way in which America’s economy affects the rest of the world. Financial markets are a more powerful influence, as today’s share-price surges prove. As America’s economy gains strength, investors may expect the Federal Reserve to bring forward its first rate rise from the expected date of mid- 2015. That could send bond yields sharply higher.
Fed officials have made it clear that, even though the pace of bond-buying will slow, they are in no hurry to raise rates. But the faster the economy grows, the likelier investors are to doubt that commitment. In Britain, speedy growth has already led to expectations that the Bank of England will raise interest rates, even though it insists that it has no intention of doing anything of the sort. If faster growth in America translates into sharply higher bond yields, it could undermine itself. And, given the Fed’s influence over global monetary conditions, it could clobber growth elsewhere too.
A more subtle, but still pernicious, risk is complacency. Politicians are always keener to take credit for growth than to tackle tough reforms. The euro area’s latest fudge on its banking union, for example, reflects an insouciance born of better economic news. That is a problem because, across the rich world, the to-do list is long. America has a huge rump of long-term unemployed (see article), and fast-rising disability rolls. Britain will remain dangerously reliant on rising house prices unless it liberalises its planning rules and invests more in airports, roads and other infrastructure. The euro area cannot enjoy real prosperity until its overhang of private debt is reduced and its young people are brought back to the labour market. Bear that in mind if you start to feel too upbeat.
From the print edition: Leaders
