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TD Economics: U.S. Economy Has Strengthened, Hurdles Remain

September 19, 2012, 06:00 AM
Filed Under: Economic Commentary

The U.S. economy is on the right track to faster growth, but obstacles will slow progress over the next year, according to a report released today by TD Economics , an affiliate of TD Bank.

"The U.S. economy is healing from the scars of the Great Recession," says TD Chief Economist Craig Alexander. "While the path to health is becoming clearer, the European recession, the drought in the Midwest, and uncertainty over domestic fiscal policy will continue to weigh on the recovery."

TD Economics forecasts economic growth to average 2.2% in 2012 and 2.0% in 2013. Growth is expected to rise to 3.2% by 2014, as the European economy makes further headway and the outlook for domestic fiscal policy becomes clearer.

The relatively slow pace of economic growth over the short-term will leave the unemployment rate unchanged at 8.1% through the end of this year. It is expected to edge down to 7.7% by the end of 2013, and improve further to 6.9% by the end of 2014.

Click here for a visual summary highlighting the key findings from TD Economics' report.

Economic growth has averaged a mere 2.2% over the last three years, half the average rate seen during the recoveries following the last 10 recessions. Such a frustratingly slow rate of growth is a legacy of the debt accumulated during the boom years and the drop in home prices that followed.

Fortunately, progress is being made on both fronts. Home prices are finally growing again for much of the nation. As asset values recover, households are making stronger headway in bringing debt burdens down to more sustainable levels.

"The improvement in household balance sheets is important," says Alexander, who calculates that households have recovered 70% of their net-worth lost during the recession. "In combination with the Federal Reserve's support for the mortgage market and commitment to continued low interest rates, it provides a foundation for faster economic growth."

Alexander acknowledges that there are still problems in the housing market. Clearing the inventory of foreclosures will continue to weigh on prices in states that have the worst backlogs. However, for the nation as whole, home prices are likely to rise modestly over the next year, further supporting household wealth.

"As home prices rise, credit conditions will further improve, and home sales and housing construction will become major contributors to the economic recovery," notes Alexander."

Although the groundwork to faster economic growth has been laid, a number of hurdles remain. Severe drought in the Midwest has devastated several important crops, including soybeans and corn. The resulting supply shortage has pushed up prices, which will eventually hit the pockets of consumers.

Alexander warns that the economic consequences of the drought should not be underestimated. He believes reduced farm output and higher prices could siphon close to half a percentage point off economic growth in the second half of this year.

A recessionary Europe and slowing emerging markets also bring added challenges. Demand for U.S. exports, once a major support to growth early in the recovery, has faltered. Uncertainty over the future of the world's second largest reserve currency is denting business and consumer confidence across the developed world.

"Europe's sickness is definitely hurting America's recovery," says Alexander. "But fiscal policymakers here at home aren't exactly helping either."

Alexander warns that the biggest drag on economic growth next year will come from tight fiscal policy. If Congress does nothing to change current law, a combination of spending cuts and tax hikes worth 5% of GDP will slam the U.S. economy next year.

Alexander feels policymakers are unlikely to go down that route, noting that this would all be too much for the still-weak economy to bear. But he warns that some fiscal drag will inevitably occur, likely as part of compromise legislation that balances spending cuts with new revenue measures. TD Economics forecasts a total fiscal drag of 1.5 percentage points in 2013, most of it occurring in the first half of the year.

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