Looking Up in 2014?

When the Fed saw how weak the upturn remained, it launched a strategy of unconventional monetary policy, combining large-scale purchases of long-term securities (quantitative easing) with promises to keep the short-term federal funds rate extremely low for an extended period of time. The goal was to encourage portfolio investors to shift into equities and other assets, with the resulting increase in their prices pushing up household wealth and consumer spending. Lower long-term rates were also expected to reduce the cost of mortgage credit, raising the value of homes.

The Fed and others were again overly optimistic about the extent to which these policies would boost GDP growth. Despite the fall in long-term interest rates, house prices reached bottom only in 2012, and the stock market did not rise faster than corporate earnings until 2013.

The economy therefore limped along year after year, with real GDP in the final quarter of each year less than 2% higher than it had been a year earlier. Employment grew more slowly than the population, and annual real-wage increases averaged only about 1%.

Fortunately, the outlook may now be changing for the better. in the third quarter of 2013, and fourth-quarter growth appears to have been relatively strong, driven by a dramatic rise in housing starts and industrial production. The sharp increases in the prices of homes and equities contributed to a roughly $6 trillion rise in real household wealth in the 12 months ending in September 2013 – a harbinger of increased consumer spending (at least by higher-wealth households) in 2014.

There are, of course, risks to the pace of expansion in the coming year. Nearly half of 2013 third-quarter GDP growth was inventory accumulation, implying that final sales rose by only about 2.5%. Businesses worry about the potential for higher corporate taxes, especially if the Republican Party loses its majority in the US House of Representatives. Although fiscal deficits are temporarily down, the combination of population aging and higher future interest rates will cause the national debt to rise faster than GDP by the end of the decade. And debt and equity markets may not continue to respond benignly to the Fed’s wind-down of quantitative easing.

So there is still much to worry about. But the US economy has a better chance of achieving a significantly higher real growth rate in the coming year than at any time since the downturn began.

Martin Feldstein is Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research.

Copyright: Project Syndicate, 2013.