The US growth model that was framed by the ‘‘Reagan Revolution’’ in the early 1980s collapsed as the subprime crisis spread to the US and, later on, the global economy. The Obama Administration, in concert with the Federal Reserve, took decisive measures to stabilize the economy and to bring the economy back to strong growth. While it succeeded in the stabilization effort, the economy recovered only at a tepid pace (see Fig.2). The disappointing recovery was partly due to the nature of the crisis—a balance sheet recession that badly damaged the financial sector and required strong deleveraging by both financial institutions and households [Mc Kinsey (2012)]—but was also due to policy choices that did not support sufficiently the pick-up in economic activity. Some of the foundations for a more sustainable and balanced growth model were laid down in this period and the next President will have to build on them.5However, in some areas, in particular on the fiscal consolidation side, the work is just starting, not least because of the fiscal policy
‘‘calculated gamble’’ made by the Obama Administration and mentioned above.
The Great Recession has probably affected negatively the potential growth of the US economy [CBO (2012)]. In addition, in the short-term strong headwinds persist, domestically and internationally, making it difficult for the US economy to even reach trend growth. Therefore, decisive action is needed by the next President to reduce these headwinds and create the conditions for stronger growth.
In the policy effort to restore strong growth, the pick-up in investment will be crucial. As Fig.2shows, the recent anemic investment growth barely compensate for the strong 3Q08–2Q09 decline. Despite favorable financing conditions and high profits, the US corporate sector remains reluctant to invest. As pointed out by the 2012 IMF Article IV report for the United States, although ‘‘…cash-rich firms
5 For an assessment of the Obama Administration’s efforts to set up a new growth model see Bertoldi (2010) and (2011).
are tapping bond markets at very low rates, enjoying easier access to bank credit, and have profit margins at historically high levels’’, business fixed investment remain weak. This may be due to the partial phasing out of accelerated depreci- ation tax incentives in January 2012, but uncertainties surrounding the future tax regime, the fiscal cliff, worries generated by the European sovereign debt crisis have certainly, and a weakening of growth in emerging market economies are also playing a major role.
Consumption has picked up on a stronger tone, but, looking forward, persistent high unemployment and a very modest increase in disposable income may become significant headwinds. In addition, the uncertainty about taxes, and possible cuts in Fig. 2 US quarterly GDP growth and its composition
16 M. Bertoldi
education and welfare services will weigh in. Although the US consumer is not known for being very forward looking, the fiscal cliff discussion and the related need to find a sustainable fiscal path for the US are likely to have him focused on these issues and their implications on his revenue in the months to come.
Against this background, there have been calls for a more predictable tax policy. As pointed out by John Taylor (2011), ‘‘demand is low in part because firms are reluctant to hire workers or invest long term not knowing what tax rates or other provisions will be. Demand for investment will increase if policy unpredictability is reduced. And consumption demand will increase if workers’
incomes increase on a more permanent basis’’. If this analysis is correct, the positive spill-over effects of a credible and coherent medium-term fiscal consoli- dation strategy on economic activity through the reduction of uncertainty channel could be significant. Baker et al. (2012), on the basis of an index of economic uncertainty they developed, found that policy uncertainty (whose main component would be tax and fiscal policy related) may have reduced GDP by 1.4 % in 2011 alone. Currently US companies are hoarding cash and there may be pent-up demand for business investment if only firms had a more predictable policy environment that would allow them to plan their investment without incurring in unpleasant surprises that could weaken their profitability. Therefore, it is clear that in the next President’s agenda the issue of the reduction of policy uncertainty, especially on the taxation side, will have to appear in a prominent position and, as in the case of the reduction in inequalities, will have to be closely linked to the medium-term fiscal consolidation strategy. This implies that this strategy will have not to rely too heavily on an increase of corporate taxes6[even if, as Brender et al.
(2012) find some margins for maneuver in this area], and rather reduce expendi- tures were possible and desirable (in light of the inequality challenge), and possibly introduce a value added tax, since it does not affect the competitiveness of American companies.
Still, a more predictable taxation environment in the framework of a credible medium-term fiscal strategy may not be sufficient to rapidly reabsorb the US output gap and bring the economy back to trend growth. As mentioned above, since 2007 advanced economies have been facing a balance sheet recession that is still pushing households and banks to deleverage. In addition, companies that piled up excessive debts before the crisis are paying them down. Even companies that were in a sound position are hoarding cash because bank lending conditions have been tightened. As a result, effective demand remains weak and firms hold investment back since there is not much scope to add productive capacity in such an environment.
Does this imply, as Paul Krugman argues7, that a new fiscal stimulus is needed to jump-start the economy, absorb the output gap and bring down unemployment?
6 Measures eliminating tax loopholes and exemptions should be preferred since they are less distortive and would put companies on a more equal footing.
7 In his recent book ‘‘End This Depression Now!’’ Krugman calls for ‘‘a stimulus of $300 billion per year’’ mostly in trasfers to states and localities and in new investment projects (pp. 214–215).
My answer is: not necessarily. If, as mentioned before, the fiscal cliff issue is addressed effectively and fiscal consolidation proceeds in a gradual and smooth way on the basis of a credible medium-term strategy, a lot of the uncertainty that affects investor and consumer behavior will have been taken away. If, in addition, measures are adopted to ensure that productivity gains will also translate in higher wages, disposable income will rise, which will in turn boost final demand. With effective demand finally materializing, firms’ investment strategies would become less conservative. As we have seen, there is currently ample room for a pick-up in investment and positive news from the wage and employment side would certainly boost private consumption, which would create the conditions for higher invest- ment.8Such a dynamic would be clearly preferable to new life support from the fiscal side, since a further increase in the US fiscal deficit and debt in the short- term would rise doubts on the creditworthiness of the country (with possible effects on interest rates and the value of the dollar) and in the medium to long-term may weigh negatively on its growth performance [Reinhard and Rogoff (2011)].
However, a new short-term fiscal stimulus should not be ruled out completely: a deterioration of the global outlook and/or a further retrenchment in effective demand due to the continuation of deleveraging trends, as well as the persistence of high uncertainty, may require counter-cyclical fiscal policy. As stated in the Communiqué of the G20 Los Cabos Summit, ‘‘should economic conditions deteriorate further, those countries with sufficient fiscal space9 stand ready to coordinate and implement discretionary fiscal actions to support domestic demand, as appropriate G20 (2012)’’.