Yes, the US economy looks resilient now — but that may not last

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The writer, a founding partner of Independent Economics, was formerly head of economic forecasting at the OECD

There has been much comment on the current resilience of the US economy. Gross domestic product grew 2.9 per cent over the 12 months to Q3, while employment growth remains strong (non-farm payrolls up 150,000 in October) and unemployment low (3.9 per cent).

This resilience seems surprising given that it comes in the face of the largest cumulative increase in official interest rates in 40 years: the fed funds rate has been hiked by 525 basis points since March 2022 — 425 points in 2022 and 100 this year.

The quantitative effects of monetary policy — both in magnitude and timing — are notoriously uncertain. That said, a central rule of thumb is that each percentage point increase in official interest rates reduces aggregate demand by 1 percentage point, with the major effect coming in the following year. On that basis, the effects of the monetary tightening to date would reduce GDP by around 4 per cent this year, with a further 1 per cent or so in 2024, relative to what it would have been otherwise.

Some estimates are higher. A recent study by the Chicago Fed, which takes into account both actual and expected interest rate changes, calculates that by Q3 this year the Federal Reserve’s tightening has pushed real GDP down by 5.4 percentage points, with a further 3.1 percentage point reduction to come by the end of 2024.

However, the effects of monetary policy, though important, are only part of the story: the other and much more neglected element is fiscal policy. And this has been imparting a quantitatively important effect in the opposite direction. At the moment it has two principal elements.

The first, and smaller, of these is the tail-end of the big fiscal boost during the pandemic. Donald Trump’s 2020 and 2021 stimulus cheques, which totalled some $814bn, or around 3 per cent of current GDP, initially went largely unspent. Subsequently, households started to run these excess savings down, but there is still a significant stock left — in August the San Francisco Fed put the value at some $500bn, or nearly 2 per cent of GDP. It is unclear how fast these unprecedented excess savings will be spent. The San Francisco Fed expects that “those funds could be available to support personal spending at least into the fourth quarter of 2023”.

The second fiscal policy element is a large expansion in government spending due to a variety of programmes this year. The size of the impulse, estimated on the basis of IMF calculations, is around 2 percentage points of US GDP. And the final effect on aggregate demand stands to be somewhat larger.

Taking all these influences into account, the present resilience of the US economy does not look very surprising. The negative influence of monetary policy by 4 to 5 per cent of GDP is being offset in large part by this year’s fiscal expansion and the running-down of much of the remaining excess savings cushion.

Next year may well be another matter, however. The spending of excess savings will largely be over and fiscal policy moves into restrictions of around 1 per cent of GDP. Meanwhile the delayed effects of the last two years of monetary tightening stand to be -1 per cent to -3 per cent of GDP.

Of course, policy settings could change. But with the present fiscal deficit approaching 6 per cent of GDP, and given the mood of Congress, any major reversal of fiscal policy in the US looks unlikely. Monetary policy could well ease, particularly if inflation falls sharply, and indeed the market currently expects the Fed to cut rates by 1.4 percentage points over the coming two years. But even if they do, bond yields, now standing at 4.6 per cent for the 10-year, are likely to prove a dampener on demand.  

Either way, we can expect 2024 to bring less talk about the surprising resilience of the US economy.