This is the U.S. economy in a nutshell, as revealed in Tuesday’s news ticker: Housing prices rose faster over the past year than they have in the past seven. Consumer confidence hit its highest level in five years. The stock market rallied another 0.9 percent to hover near an all-time high, as measured by the Standard & Poor’s 500. And the national retail price of gasoline has fallen for six days straight and is down 16 cents a gallon since late February, providing nice relief to drivers.
Which all raises an obvious question: Whatever happened to the austerity economy?
At the start of the year, it looked like 2013 would be a battle between positive and negative forces shaping the economy. On the positive side of the ledger, arguing for stronger growth to finally burst out, housing was finally gaining momentum after a six-year slump and consumers had made major progress toward righting their household finances, enabling them to ramp up consumption. On the negative side, federal fiscal policy seemed to be fighting it tooth and nail, with tax increases and spending cuts that threatened to suck the wind out of any nascent economic boom.
So far, the positives seem to be winning. Gross domestic product rose at a 2.5 percent rate in the first quarter, a bit better than the average over the past several years, and the nation added an average of 196,000 jobs a month in the first four months of 2013, a solid step up from the past few years.
There have been boosts to Americans' financial situation: Those with higher incomes are wealthier thanks to the stock market’s 17 percent rise so far in 2013 (those in the upper brackets are much more likely to hold stock investments than the rest). Middle-income Americans, whose wealth is disproportionately tied up in their homes, are becoming wealthier thanks to higher home prices (home prices are up 10.2 percent in 20 major cities in the year that ended in March, according to the S&P/Case-Shiller home price index released Tuesday). And lower- and middle-income people have benefited from falling gasoline prices.
Meanwhile, the direct evidence that tighter fiscal policy is damaging growth is scarce, so far at least; study the internal details of major economic reports, and even if you squint you don’t see a lot of concrete evidence of the squeeze.
A 2 percentage point increase in payroll taxes that took effect Jan. 1, reducing the take-home pay of all American workers, would be expected to put a big damper on consumer spending. But personal consumption expenditures rose at a 1.2 percent annual rate in the first quarter, a not-too-shabby result given the drag on after-tax income.
Similarly, while there are ample reports of sequestration spending cuts, which went into effect March 1, reducing incomes (for government contractors who are furloughed, for example, or recipients of unemployment insurance payments that have been reduced), the effects are not really evident so far in data capturing the overall state of the economy. For example, March and April employment data show steady job creation and no major change in the trend for government employment or in categories that include large concentrations of federal contractors, such as professional and business services.
So was the impact of tighter fiscal policy oversold? Not necessarily; the models used by both private forecasters and independent agencies like the Congressional Budget Office and the Federal Reserve which show a significant economic drag from tighter fiscal policy do not necessarily imply a precise timing or the exact channels through which that drag will take place. It's an exercise in counterfactuals, and what is happening now is essentially the reverse of what happened in 2009. Then, the economy contracted significantly even amid fiscal stimulus, with models concluding that the contraction would have been worse in its absence. Now, the economy is performing well even with higher taxes and spending cuts, suggesting that growth might be even stronger otherwise.
It is also evident that economists' intuition about how people will respond to changes in policy doesn't always hold up in the real data. For example, a worker whose after-tax paycheck dropped by 2 percent Jan. 1 may not have immediately cut back on spending by that amount (and retail sales data don't point to that as having happened at the start of 2013). Perhaps workers are phasing in the adjustment over months, or keeping up their spending levels but reducing their rate of saving instead. The same could be said of a federal employee seeing reduced paychecks due to furloughs.
Indeed, the full economic brunt of sequestration probably hasn’t hit yet. It went into effect March 1, but many government agencies and their contractors held out hope that it would be made less severe or eliminated entirely in negotiations over the “continuing resolution” to fund the government later in March. Thus, economists are seeing it as more likely to have its full impact later in the year than had been expected.
“It had seemed like the sequester was going to be a Q2 story,” said Michelle Girard, chief economist of RBS, referring to the quarter that ends June 30. “Now it looks like it’s more of a Q3 story, or maybe spread out between Q2 and Q3.”
More fundamentally, despite the pleasant surprises from housing, the stock market and gasoline prices, they won’t automatically translate into faster economic growth. The data that give a window into the overall speed of the recovery have been better in 2013, but not nearly as promising as measures like consumer confidence and stock prices that could presage more actual, concrete economic activity.
For the economy to continue growing even with the effects of austerity, that will have to change: Higher housing prices will need to translate into significantly more home construction. Higher stock prices will need to translate into companies making new investments. And consumers’ higher level of confidence will need to translate into spending more money, even amid the hit to incomes coming from higher taxes.
Until those things happen, there will not be the kind of full-throated economic boom that, four years since the great recession ended, America is still desperately waiting for.