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The reflation policies pursued by the major central banks don’t seem to be paying off. Even with key rates at historic lows everywhere and widespread use of unconventional policy tools, lending activity remains flat and economic growth anemic. Moreover, although strong commodity prices and rising taxes have kept price levels up until recently, the inflation rate is starting to sag—in a serious way. A lack of monetary policy coordination, the inability of central banks to offset the impact of fiscal tightening, and the still-crippling effect of deleveraging on growth are the primary ingredients of this collective failure. They are also a cause for concern. If they persist, we may well be heading for a much longer crisis than is commonly assumed—and for creeping deflation that could lead economic policy-makers to act rashly. But let’s be clear about one thing. The problem is not that central banks shouldn’t be doing what they’re doing; it’s that their combined efforts haven’t gone far enough.
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The U.S. Budget: “No, we can’t”
Beneath the surface noise of the fiscal drama that has kept Washington on edge for months lies a serious societal choice. The model in vogue in the United States since the Reagan era—low taxes and feeble welfare support—is fast unraveling in a society undergoing major change. With a tax rate some 33 percent below the OECD average and one of the highest debt-to-GDP ratios anywhere, the U.S. government’s coffers are virtually empty—leaving it ill-equipped to meet swelling demand for public programs to address such issues as rising poverty, declining geographic mobility, and a rapidly aging population.
The country has two basic alternatives:
- Either the Americans stand pat in rejecting the inevitable—a hefty increase in taxation—thus accepting, in essence, greater inequality and the demise of the American Dream;
- Or, as is more likely, they eventually agree to abandon their previous credo, in which case a secular increase in payroll and income tax will be on the agenda.
But either way, the United States of tomorrow will be a very different beast from the pre-crisis United States.
The U.S. fiscal controversy is far from over. More to the point, it has unquestionably weakened the country’s ability to reverse its debt trajectory any time soon.
The U.S. Economy: Still Far From the Mark
In an environment dominated for months by mounting fears of the worst, pleasant surprises understandably create a fair amount of enthusiasm. That leaves economists with the thankless task of urging the enthusiasts not to get their hopes up too fast. The U.S. economy has shown encouraging signs in the past few months, including revival of the housing market, higher consumer sentiment, and, in the past few days, good news from the job market. But the country is not out of the woods yet.
- The jobless rate has fallen to its lowest level since 2008. A less heartening statistic, however, is that private-sector employment has yet to recover to where it stood in 2001. In this area, the U.S. economy has not performed any better than the French economy over the past eleven years!
- The housing market is unquestionably picking up, and all the evidence points to further improvement down the road. But the key drivers of demand have taken quite a bruising from the weaker economic environment of the past few years, and real estate has lost a good deal of its power to tow the rest of the economy in its wake.
- Corporate profits in the U.S. are at a historic high. However, decelerating productivity growth has led to a significant slowdown in the rise of earnings over the last several quarters. The upshot is that by any standard, developments on the investment front have been extremely disappointing.
- Lastly, while American pragmatism can be expected to bring about a postponement of the deadline for balancing the budget, thereby limiting the “fiscal cliff” risk to the economy, the fact remains that the country’s public finances are in alarming shape. The upcoming negotiations will necessarily turn the spotlight on one of the most disturbing issues facing the United States.