The Year That Easy Money Trumped Fiscal Austerity

Before taking off for the holidays this year, a lot of professional economists made their customary forecasts as to how much the U.S. economy would grow during the final three months of 2013. The consensus was grim: Of 71 economists surveyed by Bloomberg this month, the average forecast for fourth-quarter growth was 1.6 percent. That’s pretty much a screeching halt, coming off the 4.1 percent rate from the third quarter.

The idea a few weeks ago was that killer growth in July, August, and September would sap the economy of any thunder it had left. While that seemed a reasonable presumption in mid-December—it’s essentially what happened last year—the past few weeks have shown the economy to be on much more solid footing. Capital goods orders grew 4.5 percent in November, twice as fast as even the most-optimistic forecasts had predicted. Personal income rose, and so did real consumer spending. Home prices are rising at their fastest clip since 2006. Consumer confidence is higher than it’s been since April 2008. Party.

Given all the false starts the recovery’s had over the past few years, it’s understandable that a lot of economists would play it cool. But the recent good news has led many to revise their lowball forecasts over the past few days. Michael Feroli, chief U.S. economist at JPMorgan Chase, bumped his estimate on Monday, from 2 percent to 2.5 percent. Mike Englund, chief economist at Action Economics, did the same thing last week. The risk, says Englund, has shifted from overestimating the economy’s year-end finish to underestimating it.

Unless there’s some huge downward revision, it’s all but certain that the U.S. economy in 2013 grew faster than in 2012, creating more jobs. Given all the roadblocks that Congress threw in its way, the tax hikes enacted a year ago, the massive spending cuts that went into effect with the sequester, and the incredibly shrinking budget deficit, 2013 was supposed to be a total bummer. Instead, it’s been by many measures the strongest year of the recovery.

The economy has churned through the fiscal headwinds much better than anticipated, says Feroli, “though it’s still a bit of a mystery as to why.” The answer, to many, is simple: cheap money. The ultra-low interest rates and massive bond-buying program of the U.S. Federal Reserve has offset the budget tightening far better than anyone expected. Put simply: Loose money trumped tight budgets in 2013. That’s not really supposed to happen.

“According to any Keynesian model, there’s just no way we should have seen the kind of growth we’ve seen over the past year,” says Scott Sumner, self-described market monetarist and author of a popular economics and monetary policy blog. This was supposed to be the year that the Fed’s accommodative policies ran out of gas, when loose money in essence became akin to pushing on a string, where that giant cake Fed chairman Ben Bernkanke had been baking stopped getting eaten. Rates were already near zero. What more could be done on the monetary side?

Two decisions in particular stand out, both announced in December 2012. By amping up its bond-buying program and pinning interest rates to hard numerical targets related to unemployment and inflation, the Fed gave the economy the certainty it needed to push through fiscal austerity and and gave the stock market the fuel to post its best year since 1995. Still, it wasn’t supposed to be this effective.

Not even two months ago, Larry Summers delivered a rather pessimistic (and much discussed) speech about the need to rethink how effective monetary stimulus can be in the face of such acute “secular stagnation.” In other words, how well do near zero-percent interest rates work in the face of such weak consumer demand and low inflation? In Summers’s view, not very well. At the time, my colleague Peter Coy and I labeled Summers Mr. Negative. While his speech raises interesting questions about the role of monetary policy, his pessimism now seems a touch outdated, particularly as demand has proven better than expected and job growth has continued at its strongest pace since the recession ended.

“Only the most ardent bears would look at the current data and not think it meant anything significant,” says Neil Dutta, head of U.S. economics at Renaissance Macro Research. “It’s hard to talk about secular stagnation when consumers are gobbling up automobiles at the fastest pace in five years.”

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