Economic Growth to Remain Subpar Because of Policy Uncertainty

Curtis Dubay / January 29, 2014

The Bureau of Economic Analysis (BEA) will soon release its first estimate for how fast the economy grew in the fourth quarter of 2013 and for the entire year of 2013.

The last report showed the economy moving up sharply in the third quarter of 2013 compared to where it had been earlier in the year. However, the economy is unlikely to maintain that pace of expansion, because business inventory accumulation was 40 percent of growth during that period. This means that the third quarter borrowed growth from the future.

No matter how strongly the economy grew in the fourth quarter, the BEA release is likely to show that the economy grew at an unacceptably slow pace in 2013 for this point in the recovery from the 2007–2009 recession, especially compared to the recovery from the similarly severe recession from July 1981 to November 1982.

In 1986, the fourth full year following that recession, the economy grew 3.5 percent. That is likely faster than the economy grew in 2013—the fourth year of the current recovery.

It is not just a single year in which the current recovery lags behind. Growth in the post-1982 recovery averaged 5.3 percent annually in its first three years. The current recovery averaged 2.3 percent annual growth in its first three years.

Tellingly, the policy courses chosen following the recessions varied as much as the strength of the respective recoveries. Following the 1981–1982 recession, Congress and President Reagan followed a tax-cutting and deregulation agenda. In the years following the recent recession, President Obama and Congress raised taxes substantially and greatly increased regulation.

A major side effect of that government-centric agenda is policy uncertainty, which is undoubtedly a major reason for the troubling pace of the current recovery.

Businesses across the country do not know how major legislative initiatives passed into law in recent years—such as Obamacare and the Dodd–Frank financial reform and the onslaught of executive branch regulations, especially in the environmental area—will impact their cost structures and profitability. Without being able to forecast with some degree of certainty this basic information, businesses are unable to plan future investments, which holds them back from spending and hiring.

Also holding business back is uncertainty about the government’s debt crisis. An explosion of spending on entitlements such as Social Security and Medicare as more baby boomers enter retirement is still on pace to cause a major debt crisis in the near future. Yet Washington still refuses to make sensible and long-overdue reforms to these programs.

The recent unconventional actions of the Federal Reserve are also undeniably a major contributor to policy uncertainty—specifically the Fed’s quantitative easing (QE) program of buying unprecedented quantities of government securities and mortgage-backed securities (MBS) for the first time.

How the Fed will unwind its unprecedented actions is one of the major economic questions of the day. Markets are left to wonder whether the Fed, with new chairman Janet Yellen at the helm, will continue the policy of “tapering” its extraordinary purchases of government securities and MBS started recently under chairman Ben Bernanke. They must also ponder how the Fed will reduce the enormous accumulation of assets it acquired during its QE program after it finishes tapering—or whether it will sell them at all.

This uncertainty is making banks highly cautious about lending, which is hurting businesses of all sizes that need to borrow to finance their operations and potential expansion.

While growth in 2013 for the year as a whole will likely remain weak, if the BEA report shows another solid period of growth in the fourth quarter of the year following strong growth in the third quarter, it could be the beginning of an upward trend in the economy.

But policy uncertainty will remain in 2014, so even though the underlying fundamentals of the economy may want to push growth higher this year, it will still remain below where it otherwise would be.