Let’s first start with the simple rule of accounting in order to see the basic need of global growth in developed countries, USA per se. Every dollar of government deficits has to be offset with private sector surpluses purely from an accounting standpoint, because one sector’s income is another sector’s spending, so it all has to add up to zero. Where it goes from being an accounting identity to an economic relationship is once you recognize that cyclical impulses to the economy depend on desired changes in these sector financial balances. If the business sector is basically trying to reduce its financial surplus at a more rapid pace than the government is trying to reduce its deficit then you’re getting a net positive impulse to spending which then translates into stronger, higher, more income, and ultimately feeds back into spending. Conversely, if the business sector reduces its desired surplus by less than the government sector tries to reduce the budget deficit then you end up with cyclical weakness. It’s a little heavy-going and can be challenging.
The main thing is that there’s a sort of continued improvement in the private sector, in the sense that the private sector went to running extremely large financial surpluses during the crisis. In the middle of 2009, households and businesses spent 9 percent of GDP less than they earned, meaning they were running a 9 percent of GDP financial surplus. Since mid-2009, that surplus has gradually come down as businesses and households have gotten closer to where they need to be from a long-term balance sheet perspective. They’ve paid down debt, they’ve eliminated the excess supply of housing, and that’s basically allowed them to reduce the financial surpluses that they run. They’re still running large surpluses – still 5.5 to 7 percent of GDP, but they’re no longer as large. We should expect those figures to come down as the balance sheet adjustment process makes further strides and that’s an underlying source of boost to the economy that’s happening on the one side. On the other hand though, the government has moved to increasing the fiscal drag. The pace of fiscal consolidation has picked up. Most of the fiscal consolidation has been in the state and local sector. As we move into 2013, we’ll see a big pickup in fiscal consolidation, probably, in the federal sector, and early 2013 we’re going to be at 1.5 percent of GDP due to fiscal drag.
There’s been some of that already. Over the last couple of years, the corporate sector – outside the financial sector – didn’t go into the crisis with big, heavy, over-leveraged balance sheets, but there’s been sort of improvement in the quality of balance sheets, earnings have been strong, and so the corporate sector has reduced its surpluses a bit as well. There has been, more recently, greater weakness in corporate spending over the past 6 months. Probably some of it may be attributed to fears about the fiscal cliff and fears of policy uncertainty shock in late 2012 – early 2013. If we can overcome the fiscal cliff then you will get some kind of a deal and some resolution to the uncertainty, then that might also mean that you get some pent-up demand being released in the for profit sector.
The short-run weakness that we’ve seen over the past few months is related to policy developments. Other than that, if you exclude the last 3-6 months, business investment actually hasn’t performed all that badly in the recovery so far. I think the growth rates haven’t been spectacular, but you really wouldn’t expect spectacular growth rates given how muted things have been elsewhere, but you’ve seen decent growth rates in business investment. So I think the weakness we’ve seen recently does suggest there’s been a policy impact here!! Basically, in order to have above-trend growth – a cyclically strong economy – you need to have some sector that wants to reduce its financial surplus or run a larger deficit in order to provide that sort of cyclical boost, most of the time. So In 2013 first half growth is still going to be pretty slow – 2 percent annual average, roughly – but in the second half of the year and in 2014 things would get a bit better given that if the degree of fiscal drag diminishes and the private sector boost stays on.