Animal Spirits, Monetary Stimulus and Fiscal Tightening

  • In their 2009 book entitled “Animal Spirits,” George Akerlof and Robert Shiller characterize the term as a “restless and inconsistent element in the economy…sometimes we are paralyzed by it. Yet at other times it refreshes and energizes us, overcoming our fears and indecisions.” Fear and indecision sounds like most of what we have been living through since the start of the Great Recession in 2008. Refreshing and energizing sounds like what U.S. house prices and equity prices have been doing for us lately. The path of the U.S. economy through 2013 is going to be determined to a large extent by the forces fanning and stifling our emergent animal spirits. Fanning the smoldering embers is the Federal Reserve with its historically easy monetary policy. Cheap and plentiful money is the Fed’s answer to our lingering high unemployment rate, stuck near 7.9 percent since last September. Low interest rates and open-ended quantitative easing are the Fed’s prescribed stimulus to counter the soporific effects of fiscal tightening.  We have already experienced significant fiscal tightening, with more likely to come. The increase in payroll, income, dividend and capital gains taxes this year is expected to drain $160 billion from U.S. households. The spending sequester will drain an additional $85 billion as Federal defense and nondefense spending is dialed back. The net impact of the monetary stimulus and the fiscal drag on the willingness of households to take on credit to purchase cars, homes and other things, and on the willingness of business to make new investments, will define the first half of 2013 and set the stage for the second half of the year as well. Re-emergent animal spirits will keep the economy moving forward despite the scare from barely negative GDP growth in the last quarter of 2012. However, fiscal drag will keep overall growth subdued, especially in the first half of this year.
  • The January labor data was mildly disappointing. Payroll job growth was moderate, but on the low side of consensus, up 157,000. The unemployment rate ticked up to 7.9 percent. Revisions to historical data show modestly better job growth through 2012 than previously estimated. But that does not alter the view that 2012 was another year of muddling through with an economy that was not fully engaged. Weak job gains of only 17,000 for the month in the household survey allowed the unemployment rate to tick up to 7.9 percent, essentially unchanged over the last five months.
  • Auto sales dipped for the second straight month in January, to a 15.2 million unit pace, following the surge in November that came after Hurricane Sandy. The fact that October auto sales were relatively weak, at a 14.3 million unit rate, will allow auto sales to be a net positive for the first quarter even if they are flat to slightly declining in February and March.  House prices increased through November according to the Case–Shiller 20-City Composite Index, which was up 5.5 percent from November 2011. Sales of both new and existing homes dipped in December. A weak Pending Home Sales Index for December points to flattish sales in January, too. Business investment came back in 2012Q4 after stumbling through Q3, despite the -0.1 percent real GDP growth rate for Q4.  Gyrations in defense spending and inventories that pulled Q4 GDP slightly negative will likely not extend into 2013Q1.

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Click here for the complete February U.S. Economic Update: USEconomicUpdate0213.

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