Where is the economy heading in 2013? This question was a much discussed topic during the presidential race, but it was always framed in electoral politics. Now that we finally have the election behind us we can consider the question on its own terms. There are long-term challenges for the economy, but of more pertinent concern is what does the coming year have in store. Here are the problems that I see going into 2013 in no particular order:
(1) Housing is Not in Recovery — Foreclosures, short-sales, and unemployment problems look to continue limiting the number of homebuyers and housing will continue to struggle (though some local levels will see recovery, nationally this remains a problem).
(2) Unemployment Still Will be High — Millions of workers remain unemployed for more than 6+ months and will not re-enter the labor force easily or quickly, labor force participation won't increase overnight, productivity has increased since the recession even though total employment has fallen, and structural changes such as shifts in the sectors of large scale employment will be a problem for a while.
(3) Regulatory and Tax Uncertainty for Business Investment —There are a host of Dodd-Frank regulations waiting to be implemented, and another four years of Obama means increased environment and labor regulations slowing down business.
(4) Private Debt Deleveraging — Probably the biggest challenge is that mortgage debt has only slowly declined relative to housing prices, and while housing prices are at 2003 levels, mortgage debt is 67 percent higher today than in 2003. This means there is a lot more deleveraging to go through. As I wrote for RealClearMarkets this morning:
If you are a Keynesian, then consumers shedding their existing debt means a reduction in aggregate spending, stalling the key engine of growth…. The story isn't much better if you prefer a more supply-side economic approach to jumpstarting growth, and want to reduce taxes and regulations on businesses so they can thrive. If businesses, particularly small businesses whose expenses are part of their household budgets, are more interested in deleveraging than expanding, then tax cuts and regulatory burdens will have only a small effect on economic growth in the short run. This does not mean these policies should be ignored, but rather that their true value will be to set the stage for a stronger long-term recovery as lower taxes and regulatory costs will allow these businesses to clear their balance sheets faster. The deleveraging cycle still needs to process.
(5) Fiscal Cliff? — It is not clear yet how Congress will address the fiscal cliff, but if we go over entirely it will have a negative impact on the economy. Whether that is a problem depends on how bad the above four problems make the economy anyway and whether you believe short-term pain from reduced government spending is worth the long-term need to cut the deficit and national debt.
And none of this gets into the long-term challenges for the economy like the national debt, out of control entitlement spending, QEnfinity as monetary policy, declining education outcomes, and rising health care costs.
Still despite all of this, I'm a cautionary optimist because we are in a better place than 2008, and most of this is more likely to mean a stagnating economy (growing around or under 2 percent) rather than another recession. But you do the math and decide whether this is what recovery looks like or not.