The Year in Economics: Presidential Politics, Job Creation and the Fiscal Cliff

Facing headwinds from policy gridlock, middling consumer activity and developments abroad, businesses approached hiring and other investments cautiously over the last year. Weak job creation proved a remarkably consistent source of frustration. The unemployment rate fell by 100 basis points over the last year, but the tally of net new jobs showed no improvement from 2011. Ever a deceptive measure, the falling unemployment rate captured that Americans opting out of the workforce matched Americans finding work nearly one-for-one. For too many American families, the recovery is too long in coming.

In spite of the recalcitrant challenges to the recovery, there have been some clear improvements that position us for stronger gains over the next year. For a moment, assume the fiscal cliff is resolved in favor of extending tax cuts. Remembering why the sequestration deadline was ever set, we have failed to address the larger threat to our economy’s long-term health but have also agreed to forgo the consequences we set for ourselves.

The upside of failure is that the current program of tax and spending measures will live to see another day. The benefits are well apportioned among businesses and consumers, the latter on the cusp of a nascent housing recovery. If that recovery is not upended by austerity, the positive impact on household wealth and consumer sentiment will ripple through almost every facet of the economy. It has the potential to surpass anything gained from the uptick in manufacturing, technology or the energy sector thus far.

What else might the next year bring? Some broad brush strokes for 2013, by the numbers:
The Economy: The broad recovery fell short of expectations in 2012. A year ago, economists projected that growth of 2.3 percent in 2012 would accelerate to 2.7 percent in 2013. In the final tally, 2012 will register growth just below 2 percent. Assuming the eleventh-hour resolution of the fiscal cliff, housing, consumers and business investment will fuel only a marginal improvement in 2013.

The Job Market: The consensus projection in late 2011 set the unemployment rate at 8.5 percent at the end of 2012 and 8 percent a year after that. By this measure, the job market has significantly outperformed expectations. On its current trajectory, the baseline forecast shows unemployment drifting down in 2013, reaching the Fed’s newly announced threshold the following year.

This trick of accounting masks a decline in the labor participation rate, to its lowest level in more than three decades. Turning the success story of the lower unemployment rate on its head is elementary. Holding the labor participation rate constant, the unemployment rate as of November would be 9.2 percent.

Interest Rates: The year opened with the 10-year treasury yielding 1.70 percent. As of last Friday, it was hardly changed. Last December, the consensus estimate projected that yields would approach 2.8 percent by now. From last week’s announcement of a new asset purchase program by the Federal Reserve, the market can now infer that short and long rates will remain at historically low levels until 2015 at the earliest. For good and bad, and to the extent that the Fed can exert control over the long end of the yield curve, monetary policy will play a continued role in lifting commercial property prices.

Lending: Commercial property markets have outperformed the broader economy, in New York as much as anywhere. Investment activity remains weighted to the largest markets, where the confluence of investors and lenders has reinforced the draw of liquidity. Yield erosion has given way to construction activity and to secondary market spillovers that have benefited from re-engagement by banks and conduit lenders. In a pattern that will carry over into 2013, competition to lend in the apartment market and on the most coveted commercial sales will see many lenders take undue interest rate and balloon risks.

Housing: If there was an inflection in 2012, it was in housing. In The Wall Street Journal’s December 2011 survey of economists, only a small minority anticipated an increase in real house prices before 2015. After so many false starts and ineffectual policy interventions, skepticism has dominated assessments of the turnaround time line. Evidence of a broadening housing recovery began to emerge at midyear, ahead of the labor market and in spite of the hurdles would-be homeowners face in qualifying for mortgages. No one should look a gift horse in the mouth, but there are corners of the apartment market that will struggle to maintain their momentum.
dsc@chandan.com

Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.