Photographer: Pete Marovich/Bloomberg

Strife Between Democrats and Republicans Curbs Business Spending

Weak corporate investment is just one challenge facing policy makers as 2017 kicks off

New Year, new global economy? The world's growth trajectory could be headed for some major changes in coming months: a new U.S. Congress convenes on Tuesday and America will inaugurate a new president later this month, Brexit details will be hammered out, and Europe will see several big-deal elections.

Today's version of Bloomberg's weekly economic research wrap looks at some of the major challenges facing policy makers entering the year, starting with still-weak corporate investment. It also takes stock of where central banks sit — think of it as wonky context to start 2017. Check this column every week for the latest in top economic studies from around the world. 

When politicians yell, companies hoard cash

Businesses haven't been spending in the U.S., and it's possible that Capitol Hill dysfunction is partly to blame. A 10 percent rise in the U.S. partisan conflict index (a gauge that tracks the degree of political disagreement in the nation based on newspaper articles) results in a 0.4 percentage point increase in average cash-to-total assets above trend about one year after the shock, based on new Bank of England research. The working paper used data on cash holdings from the Compustat database for the period between 1985 and 2014.

This matters, because it can be bad for the economy if companies are hanging onto cash rather than investing to grow their businesses. "These insights are important for conveying to politicians the importance of good policy and the broader signaling effects of political dysfunction," the authors write.

Does partisan conflict impact the cash holdings of firms?
December 2016
Available at the Bank of England website

The equity issue

Getting along is far from the biggest issue political types need to work on. One concern that transcends borders is growing inequality: research finds that a highly uneven income distribution hurts growth.

Take this recent paper, which is scheduled to be discussed at the American Economic Association's annual meetings in Chicago this weekend. Princeton University's Adrien Auclert and Massachusetts Institute of Technology's Matthew Rognlie find that a temporary boost to inequality lowers output modestly, partly because higher-income people are less likely to spend every additional dollar they earn. A permanently wider income gap can have a much larger effect on growth. 

Not all hope is lost if inequality increases. The paper's result assumes neither monetary nor fiscal policy step in to boost consumption, and the authors write that the analysis "highlights inequality-driven secular stagnation as a theoretical possibility, but also stresses that expansionary fiscal and monetary policy interventions can both mitigate it." 

Inequality and Aggregate Demand
Published November 2016, to be discussed Jan. 7, 2017 
Available at the AEA website 

Labor market on the brink

On the bright side, new policy makers in the U.S. will be working with an economy that's looking pretty solid, jobs-wise. 

Goldman Sachs economists say the labor market is now near full employment and on course to overheat slightly in 2017, so wage growth is likely to reach 3 percent to 3.5 percent this year. The Fed will also hit its 2 percent inflation target in 2017, they project, and the central bank will make three rate increases. 

Meanwhile, economists at JP Morgan see the expansion getting longer in the tooth: while they acknowledge that still-falling joblessness means that labor slack continues to be reduced, they also warn that the U.S. economy has rarely managed to stay at or above full employment for more than a few years before a recession begins. "Our models still put the risk of recession starting within two years at around one-half, moderately above the historical average of 34 percent," analyst Jesse Edgerton wrote in a Dec. 22 note. 

Various research notes
Published in December 2016
Available to clients 

Risk on, risk off

The Fed's dot-plot suggests it could make three rate increases in 2017 on top of the two hikes it's made since December 2015. That would make it one of the few major central banks to gain any meaningful distance above zero rates. 

Other monetary authorities are maintaining their historically low settings for now, and Fed economists have taken a look at whether those ultra-low rates are leading to excessive investor risk-taking. It’s happening, they say, but not enough to suggest any major near-term risk to financial stability.

The researchers look at the euro area, U.K., Japan and Canada and finds signs of a reach for yield in foreign debt investments, including bigger exposure to duration and credit risk in their portfolios of U.S. corporate bonds. "Looking forward, if risk-shifting portfolio shifts by foreign investors from low-rate advanced foreign economies become more pronounced, they could contribute to valuation pressures in U.S. corporate debt markets," according to the study. That would be a flashback to the run-up to the financial crisis, they note.

"Low-For-Long" Interest Rates and Portfolio Shifts in Advanced Foreign Economies
Published Dec. 30, 2016
Available at the Federal Reserve Board website

    Before it's here, it's on the Bloomberg Terminal.