It is true that the American economy appears resilient now – but this may not last

It is true that the American economy appears resilient now – but this may not last

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The writer is a founding partner at Independent Economics and a former head of economic forecasting at the OECD

There has been much commentary about the current resilience of the US economy. GDP grew by 2.9 percent over the 12 months to the third quarter, while employment growth remained strong (nonfarm payrolls rose by 150,000 jobs in October) and unemployment was low (3.9 percent).

This flexibility seems surprising given that it comes in the face of the largest cumulative increase in official interest rates in 40 years: the federal funds rate has been raised by 525 basis points since March 2022 – 425 points in 2022 and 100 this year.

The quantitative effects of monetary policy – ​​both in terms of magnitude and timing – are highly uncertain. However, the basic rule of thumb is that every percentage point increase in official interest rates causes aggregate demand to fall by one percentage point, with the main effect coming in the following year. On this basis, the effects of monetary tightening so far would reduce GDP by about 4% this year, with another 1% or so in 2024, relative to what it would otherwise be.

Some estimates are higher. A recent study by the Chicago Fed, which takes into account actual and expected changes in interest rates, suggests that by the third quarter of this year, Fed tightening had reduced real GDP by 5.4 percentage points, with another reduction of 3.1 percentage points in the future. End of 2024.

However, the effects of monetary policy, while important, are only part of the story: the other, more neglected element is fiscal policy. This produced a quantitatively significant effect in the opposite direction. At the moment it has two main components.

The first, and smallest, is the end of the big fiscal consolidation during the pandemic. Donald Trump’s 2020 and 2021 stimulus checks, which totaled about $814 billion, or about 3 percent of current GDP, were largely unspent to begin with. Later, households began to reduce these excess savings, but there was still a large stock left – in August, the Federal Reserve Bank of San Francisco estimated the value at $500 billion, or roughly 2 percent of GDP. . It is unclear how quickly these unprecedented surplus savings will be spent. The Federal Reserve Bank of San Francisco expects that “these funds could be available to support personal spending at least through the fourth quarter of 2023.”

The second element of fiscal policy is the significant expansion in government spending due to a variety of programs this year. The size of the payment, estimated on the basis of International Monetary Fund calculations, is about two percentage points of US GDP. The final impact on aggregate demand is expected to be somewhat larger.

Taking all these influences into account, the current resilience of the US economy does not seem so surprising. The negative impact of monetary policy at 4 to 5 percent of GDP is largely offset by the fiscal expansion this year and the depletion of a large portion of remaining excess savings reserves.

However, next year may be another matter. Spending of excess savings will largely end, and fiscal policy will move toward restrictions of about 1 percent of GDP. On the other hand, the lagged effects of the last two years of monetary policy tightening are expected to range between 1 percent to 3 percent of GDP.

Of course, policy settings can change. But with the current fiscal deficit approaching 6 percent of GDP, and given the mood in Congress, any major shift in fiscal policy in the United States seems unlikely. It is possible to ease monetary policy, especially if inflation falls sharply, and the market currently expects the Federal Reserve to cut interest rates by about 1.4 percentage points over the next two years. But even if they do, bond yields, now at 4.6 percent for 10 years, are likely to act as a dampener on demand.

Either way, we can expect 2024 to bring less talk about the surprising resilience of the US economy.

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