Recovering US economy faces fiscal challenge

Encouraging figures this week suggested the US economy is at or near the trough of the recession. Output shrank in the second quarter at 1 per cent at an annualised rate, sharply down from the first quarter contraction of 6.4 per cent.

The bold fiscal stimulus has helped. The package was not as front-loaded as it should have been; but it is having an effect. The Obama administration deserves credit for prompt action, but needs to follow through.

Bear in mind that despite the better news, the strength of the coming recovery is still in doubt. The obverse of the impact of the stimulus in the second quarter is the continuing weakness of private demand. Consumption and business investment must revive for a vigorous and sustained recovery. With household balance sheets still beaten down, unemployment high and continuing fragility in the US financial sector, it is too soon to celebrate.

The housing market will be crucial in supporting broader demand. This week saw better news here too. One month does not a recovery make. In some places, house prices have halved. But prices may at last be rising. In all but two of the 20 cities tracked by the Case-Shiller index, prices were up in June. They had fallen throughout the spring, and just months ago further significant drops were seen as likely. If house prices have indeed bottomed out, that augurs well for reversing the trend of foreclosures, for a quicker stabilisation of the banks than once seemed probable and for greater consumer and business confidence.

Looking ahead, the fiscal policy challenge is daunting even if these signs of improvement are real. The White House and the independent Congressional Budget Office have both released new fiscal projections. They point to budget deficits of roughly $1,500bn this year and next. More worrying, both expect the deficit to remain about 4 per cent of GDP through to 2019 and beyond – on the basis of quite optimistic economic assumptions.

It was unquestionably right to provide a bold fiscal stimulus, and until private demand has revived it is too soon to think of withdrawing it. But it is certainly not too soon for a plan to bring the budget back towards balance in the medium term. Indeed, without such a plan, a durable expansion must be very much in doubt.

US administrations are constitutionally ill-equipped to commit themselves to medium-term fiscal balance. Congress raises the revenues and chooses how to spend them: its political complexion changes every two years and it is always disinclined to think ahead. But the White House can take the initiative in saying how the medium-term deficit should be brought back under control. So far it has said little on the subject, and nothing persuasive. That must change.

Source: FT

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