The United States celebrated the New Year with economic pain rather than champagne as it coped, once again, with the fiscal crisis that never was. However, fundamentals remain strong, and growth engines should begin to pick up steam by the second half of 2014.
The United States has narrowly avoided beginning the New Year with another budgetary stalemate, setting the stage for almost two years of relative budget calm.
2013 began with a last-minute deal to mitigate some of the impact of the “fiscal cliff” and concluded with a budget deal that sets overall spending levels for the remainder of fiscal year 2014 and all of fiscal year 2015. This is significant; these “cliff hangers” have been costly to the US economy. Beyond the direct impacts resulting from what has evolved into an austerity agenda, these crises and near-crises have damaged consumer and business confidence, thereby serving as a further constraint on growth. However, ambiguity as to what path the Fed will follow as it scales back on its current course of monetary easing still remains.
From fiscal cliff to government shutdown and beyond: Tracking the course
The United States came perilously close to default in the summer of 2011 and only avoided this unprecedented event when the president and Congress agreed to the Budget Control Act (BCA) of 2011. This act provided an increase in the debt ceiling in exchange for caps on federal spending for the next 10 years, to be enforced by the threat of sequestration—across-the-board cuts in most discretionary programs. Since Congress failed to pass a spending bill that met the BCA’s criteria by January 15, 2012, sequestration was set to begin on January 2, 2013.1 A broad series of tax cuts were also scheduled to expire at the start of 2013, including the Bush income tax cuts, the 2 percent payroll tax holiday, capital gains tax, the estate tax, and the R&D tax credit. Adding to the uncertainty was the fact that the country was, once again, bumping up against the debt ceiling.
The resolution of the fiscal cliff on January 1, 2013 was a modest deal that allowed only a small number of the scheduled tax expirations to occur (the income tax on high earners and the payroll tax holiday) and delayed the sequester’s deep spending cuts for two months in hopes that a budget could be developed that honored the BCA’s spending caps without making the across-the-board cuts. That effort was unsuccessful, so federal agencies had to reduce spending for the remainder of fiscal year 2013. According to the White House Office of Management and Budget, the effective reductions were approximately 13 percent for nonexempt defense spending and 9 percent for nonexempt nondefense spending.2
In February 2013, Congress suspended the debt ceiling until mid-May. As a result of some very large repayments to the Treasury from the government-sponsored housing agencies (Fannie Mae and Freddie Mac) and by using “extraordinary measures” to move funds between government accounts, the Treasury was able to keep the debt below the ceiling until mid-October. Meanwhile, Congress did not produce a budget to fund fiscal year 2014, and the federal government went into a partial shutdown on October 1.3
After a 16-day shutdown and with a government default looming, Congress passed another temporary fix, funding the federal government through January 15. In a rare but welcome move, a bipartisan budget plan was passed in advance of that deadline, providing a spending framework through September 2015. However, the debt ceiling, which has been suspended through February 7, was not addressed, and it remains a source of uncertainty on the horizon.
These fiscal impasses and their ongoing, partial resolutions have negatively impacted the US economy.
According to the Congressional Budget Office (CBO), these fiscal impasses and their ongoing, partial resolutions have negatively impacted the US economy. CBO estimates that economic growth in fiscal year 2013 (Q4 of calendar year 2012 to Q4 of calendar year 2013) would be roughly 1.5 percent higher, if not for the fiscal tightening required by the BCA.4 More recently, the CBO estimated that, if the spending limits mandated by the BCA had been eliminated starting August 1, 2013, real GDP would be 0.7 percent higher, and employment would increase by 900,000 in Q3 of calendar year 2014 (the end of fiscal year 2014) relative to the levels projected under current law.5
Impact on confidence
However, it is not only the actual resolutions that become law that are negatively affecting the US economy. It is the process through which these results are achieved. Both the brinksmanship over the debt ceiling in 2011 and 2013 and the government shutdown in October 2013 affected consumer and business confidence. As the country approached default during the summer of 2011, consumer confidence fell sharply, and it took months to recover. With the government shutdown and another threat of imminent default, consumer confidence again dropped abruptly this past October, with a further decline in November.
Business confidence also was adversely impacted (see figure 1). Deloitte’s quarterly survey of chief financial officers of major North American companies illustrates how executives’ perceptions of their businesses’ outlook are affected by actions in Washington.6 Clear dips occurred at the debt ceiling showdown in 2011, the fiscal cliff debate at the end of 2012, and the approach of the government shutdown in October 2013.7
One manifestation of the damage these actions do to confidence is visible in the recent relationship between job openings and hires, as measured by the Bureau of Labor Statistics’ Job Openings and Labor Turnover survey (see figure 2). In recent months, the job opening rate has increased much more quickly than the rate of hiring. This implies that companies are seeing the need to increase employment and are therefore posting job openings and conducting interviews, but that uncertainty is making them reluctant to actually make job offers. Additionally, employee uncertainty about other job prospects is keeping the “quit rate” low.8
Implications for the outlook
However, even with the uncertainty being generated by Washington, the US economy’s fundamentals continue to improve. Growth accelerated during 2013 and averaged 2.6 percent through the third quarter (annualized basis), unemployment continues to fall, and inflation remains in check. With the unemployment rate reaching 7 percent, the Fed decided to make a slight downward adjustment to its current program of quantitative easing.
However, many aspects of employment point to a labor market that may be weaker than the top-line unemployment rate suggests. These include high numbers of people who have been unemployed for extended periods or are working part-time because they cannot find full-time work.
Another factor that suggests that the labor market is softer than apparent at first glance is the decline in the labor force participation rate. After peaking in 2000, the United States’ labor force participation rate declined slowly, then stabilized between 2004 and the onset of the recession (December 2007). However, during the recession and through the current recovery, the labor force participation rate has been declining at a fairly rapid pace—and it is now 5 percent lower than it was prior to the onset of the recession (see figure 3).9
The proportion of people in the economy who are working or looking for work can change over time for many reasons. For example, much of the growth in labor force participation beginning in the mid-1960s reflected the large number of women entering the labor force. Contributing to the current period’s decline is a higher proportion of young people choosing to go to college and the retirement of the Baby Boomers. But these factors account for only part of the reduction. The decline in labor force participation for those between the ages of 16 and 24, for instance, does reflect an increase in the collegiate population, both at the graduate and undergraduate levels (see figure 4). However, the decline in labor force participation rates for this group halted in 2010 and has been fairly stable over the past three years.
Meanwhile, the labor force participation rate of those 55 and over actually continued to increase during the recession before stabilizing at around 40 percent (see figure 5). With this group’s average participation rate so much lower than that of the other age groups, the greater the proportion of people in this age group, the lower the overall labor market participation rate will be.
While there are many explanations for the shifts in labor force participation rates among 16–24-year-olds and those aged 55 and over—ranging from the benign or positive (e.g., attending college or having sufficient resources to retire) to the negative (e.g., dropping out of the labor market because job prospects are very poor)—the change in the labor force participation rate among 25–54-year-olds is more likely to have been caused by poor labor market conditions (see figure 6). While certainly some in this group returned to school or retired, poor job prospects seem to be a more likely explanation, given the magnitude of the shift.
The big question for policymakers at the Fed as they ponder further reductions to their monthly purchases of bonds and mortgage back securities is, what proportion of those who left the labor force in recent years will decide to reenter the market and look for a job when they think that the market has sufficiently improved? The actual size of the labor force between the ages of 25 and 54 is 4.5 million below its prerecession peak, but the total population in this age group only decreased by 1.5 million over the same period. This creates a pool of approximately 3 million people that could move from outside the labor force into the ranks of either the employed or the unemployed—which, in turn, could move a 7 percent unemployment rate upward very quickly. This analysis suggests that the Fed will move more slowly than some observers expect.
But irrespective of exactly when the current round of quantitative easing will start to taper off, the United States’ growth engines should begin to pick up steam during 2014.
But irrespective of the exact path that the tapering of the current round of quantitative easing will take, the United States’ growth engines should begin to pick up steam during 2014. Near-term growth prospects improved since Congress and the Administration made a New Year’s resolution, of sorts, to provide for relative budgetary calm—at least for the next two years.
EndnotesView all endnotes
- Bill Heniff Jr., Elizabeth Rybicki, and Shannon M. Mahan, “The Budget Control Act of 2011,” Congressional Research Service, August 19, 2011, http://www.fas.org/sgp/crs/misc/R41965.pdf.
- Karen Spar, “Budget ‘sequestration’ and selected program exemptions and special rules,” Congressional Research Service, June 13, 2013, http://www.fas.org/sgp/crs/misc/R42050.pdf.
- Approximately one-third of the civilian federal workforce (approximately 800,000 workers) was furloughed the first week of the shutdown (Tuesday, October 1 through Friday, October 4). Workers deemed “essential,” defined as those who provide for “the national security” or for the “safety of life and property,” remained on the job. At the start of the second week of the shutdown, the Secretary of Defense declared almost all civilian Department of Defense employees to be “essential.” Therefore, as of Monday, October 7, an additional 350,000 federal workers were back on the job, reducing the total number of furloughed workers to 450,000.
- Wendy Edelberg, “Automatic reductions in government spending—aka sequestration,” Congressional Budget Office blog post, February 28, 2013, http://www.cbo.gov/publication/43961.
- Congressional Budget Office, letter to Congressman Christopher Van Hollen, “Eliminating the automatic spending reductions specified by the Budget Control Act would affect the US economy in 2014,” July 25, 2013, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44445-SpendReductions_1.pdf.
- CFO Signals, What North America’s top finance executives are thinking—and doing, Q3 2013, http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/CFO_Center_FT/us_CFO_Signals_3Q13_HighLevelReport_091913.pdf, accessed December 17, 2013.
- Bureau of Labor Statistics, Job openings and labor turnover survey, November 22, 2013.
- Bureau of Labor Statistics, Labor force statistics from the current population survey, United States Department of Labor, http://www.bls.gov/cps/, accessed December 17, 2013.