Age of Austerity Nearing End May Boost Global EconomySimon Kennedy
The age of austerity may be nearing an end as governments ease the fiscal cuts that restrained economic recoveries.
After three years of slashing budgets bloated by recession and the stimulus deployed to fight it, U.S. and euro-area officials are finding less need to retrench as their previous efforts and improving economic growth help narrow deficits.
This will allow them to tighten policy next year by the least since they began in 2011, according to estimates by the International Monetary Fund. The lender projects the fiscal reduction by Group of Seven nations will be almost half this year’s pace as the average budget shortfall drops to about a quarter of where it was just three years ago.
“The softening of the fiscal drag is likely to play an important role in supporting a pick-up in global growth,” said Jose Ursua, a New York-based economist at Goldman Sachs Group Inc., referring to the negative effect of budget-chopping on an economy.
Economists at Goldman Sachs and Deutsche Bank AG say the relaxation will help industrial economies almost double their rate of expansion next year to 2.2 percent, the most since the recovery from recession in 2010. The Federal Reserve -- including Vice Chairman Janet Yellen, nominated to be its next chairman -- already is taking note as it considers when to curtail its own stimulus.
Ursua calls the shift a “major contributor” to an acceleration in U.S. growth next year to 2.9 percent from 1.7 percent this year. That in turn helps explain why Goldman Sachs forecasts the Standard & Poor’s 500 Index will climb to 1,900 at the end of 2014 from 1,792.81 at 4 p.m. in New York yesterday.
In Europe, signs that the so-called peripheral economies such as Spain and Greece are getting more control over their budgets will reduce the “risk premium” investors demand to hold their bonds over similarly dated securities, according to Bill Street, head of investments for Europe, Middle East and Africa at State Street Global Advisors in London.
The gap between 10-year yields for Spain and Germany was 2.39 percentage points today, down from 6.5 points in July 2012. “You’ll see spreads coming in, definitely,” Street said.
Reduced austerity would end a period when governments raised taxes and cut public spending, reining in their economies, as they tried to restore the fiscal order they abandoned to fight the worldwide recession.
Adjusting budgets to ignore interest payments, the IMF says the so-called primary deficit in the G-7 countries reached an average 5.1 percent in 2010 when also smoothed to ignore large economic swings and will fall to 1.2 percent next year.
The unprecedented retrenchments between 2010 and 2013 amounted to 3.5 percent of U.S. gross domestic product and 3.3 percent of euro-area GDP, according to Julian Callow, chief international economist at Barclays Plc in London. For the U.S., Deutsche Bank economists estimate nonfarm payrolls would have gained 400,000 a month this year instead of about 186,000 without fiscal restraint.
The U.S. and Europe also fell victim to uncertainty shocks. First the euro area struggled to tame markets rattled by debt burdens and bailouts. Then American lawmakers partially closed the government for 16 days and squabbled over raising the $16.7 trillion debt ceiling before agreeing on a short-term fix that suspended the borrowing cap until Feb. 7.
What matters for economists is the fiscal drag. The greater the tightening, the more restraint as companies and consumers face higher taxes, and there’s less government hiring or spending on programs such as education or roads and other infrastructure. This then feeds through the economy as households and businesses pull back on their own spending.
Even a reduction in the amount of drag can bring relief to an economy, Ursua said. The IMF projects the cyclically adjusted primary deficit for the U.S. will fall to 1.2 percent of GDP in 2014 from 1.9 percent this year and 4.2 percent in 2012. Such a slowing in the rate of decline leads Ursua to calculate fiscal drag will fall by 1.6 percentage points next year. It rose 1.2 points this year.
The room for error lingers. U.S. lawmakers still must agree on a spending plan for the rest of the fiscal year -- which may trigger more automatic spending cuts, including to defense programs -- and they face the Feb. 7 deadline for raising the borrowing limit.
A survey of Bloomberg subscribers last month identified political gridlock in Washington as the biggest threat to global growth. Events there are “the cause of many of the problems” with the economy, William Brodsky, executive chairman of CBOE Holdings Inc., the biggest options-exchange operator, told a Bloomberg LP conference on Nov. 20.
Still, neither Democrats nor Republicans have the appetite for more spending cuts, and changes to the tax code probably won’t come soon, according to Nomura Holdings Inc. economists. If the negotiations go smoothly, the economy could accelerate faster toward the 3 percent they project for the second half of 2014 and into 2015, they wrote in a Nov. 25 report.
GDP rose at an annualized pace of 3.6 percent in the third quarter, faster than initially reported, led by the biggest increase in inventories since early 1998, according to Commerce Department data released today.
Not everyone will be tightening their belts. After providing stimulus this year as part of his campaign to defeat deflation, Japanese Prime Minister Shinzo Abe is raising the country’s sales tax to 8 percent in April from 5 percent. Partly to counter the impact, he’s also planning an 18.6 trillion yen ($182 billion) spending and loan package.
The U.K. government, which released new forecasts today, is sticking to a strategy of closing its budget deficit by 2019. Goldman Sachs predicts greater restraint in emerging markets, including China, Russia, Brazil and India.
If the U.S. does relax, it would be welcome news for the Fed as it debates tapering its monthly purchases of $85 billion in Treasuries and mortgage-backed securities.
“I would expect if there were less fiscal drag, and I hope there will be less going forward, that the economy’s growth rate is going to tick up,” Yellen said on Nov. 14 as she addressed senators considering her candidacy to replace Ben S. Bernanke as chairman.
“The lack of a shutdown and a stronger fiscal impulse is a net positive for the Fed next year,” said Drew Matus, deputy chief U.S. economist in Stamford, Connecticut, at UBS Securities LLC. The firm is predicting the central bank will begin tapering in January.
What also may help the U.S. are state and local governments: Their $1.74 trillion in inflation-adjusted spending is 50 percent larger than the federal sector, and they employ seven times more people, according to Joseph LaVorgna, chief U.S. economist at Deutsche Bank in New York. Having declined for three years in a row for the first time since World War II, their spending jumped 1.5 percent in the third quarter, the most since the second quarter of 2009, he said.
“The positive incremental effect from stronger state and local activity is considerable,” said LaVorgna, who predicts the U.S. will expand 3.2 percent next year after 1.8 percent this year.
Driven to austerity by debt crises, Europe also is finding room to relax. The IMF data suggest the region’s adjusted primary budget surplus will grow for a second year, rising to 1.4 percent of GDP in 2014 from 1.1 percent this year and a deficit of 2.6 percent in 2010. Greece’s shortfall will decline to 5.4 percent of GDP from 13.6 percent in 2009.
The cutting helped deepen the longest recession since the euro began trading in 1999 and led to fatigue among politicians and voters, said Giada Giani, an economist at Citigroup Inc. in London. With less pressure from bond investors to tackle fiscal excesses, countries will take a break and across the continent, fiscal policy won’t be constrictive for the first time since 2009, she said.
“Growth suffered more than originally envisaged,” said Giani in a Nov. 22 report titled “Is This The End of Austerity?” “The slowdown in fiscal consolidation is likely to continue in 2014.”
European Central Bank President Mario Draghi reinforced this today when he said at a news conference that any cutbacks should be “growth-friendly and have a medium-term perspective.”
It still may take until 2015 for the drag to really diminish, given that policies implemented in 2013 have yet to take full effect, according to Laurence Boone, chief European economist at Bank of America Corp. in London.
“It’s important overall the drag disappears, as growth needs to come back,” said Boone, who predicts the euro-zone economy will expand 0.8 percent next year after shrinking 0.5 percent this year.