Promising Picture for U.S. Economy
The outlook for the U.S. economy in 2005 is promising. Low overall inflation and continued improvement in the job market will provide the base for solid economic growth next year.
Following a year of gains in broad economic measures such as per capita income and employment (see chart 1) as well as strong real gross domestic product (GDP) growth, it would be tempting to describe the 2005 national forecast as bright and sunny with few headwinds. But that description wouldn't provide a complete picture because some of the uncertainty and risks that clouded prior years' outlooks, such as geopolitical concerns in the Middle East and higher oil and energy prices, remain challenges for the economy in 2005.
That the nation's economy has continued to grow despite the presence of these risks indicates its resilience. Additional progress in addressing these challenges--especially those the United States can influence directly, such as fiscal imbalances--will be important to sustaining the expansion.
In 2004, performance as measured by real GDP mostly matched analysts' expectations. In 2005, overall GDP growth is anticipated to be similar to that experienced in 2004.
Strengthening labor markets and solid improvements in income should continue to support real personal consumption growth in 2005. Moderating energy prices would also boost consumer spending next year. But growth in consumer spending may be restrained somewhat as the effects of past fiscal and monetary policy actions run their course. On the other hand, reduced monetary policy accommodation will help contain core inflationary pressures in 2005.
The resurgence of business investment spending that began in mid-2003 has brought capital spending back to prerecessionary levels. This year, tax incentives supported business investment, but these incentives are due to expire at the end of 2004, potentially causing a moderation in investment spending in the first part of 2005. Corporate balance sheets appear to be in good shape as strong profit growth during 2004 provided business with ample funds to support capital spending.
Residential investment spending continued to surge ahead in 2004, bolstered by low interest rates and strong income growth. Modest increases in mortgage interest rates in 2005 could dampen growth in residential investment spending. But even so, overall housing activity is expected to remain at high levels, supported by robust income and employment growth.
The large U.S. current account deficit has placed downward pressure on the dollar's exchange rate during 2004. When combined with continued economic growth in the rest of the world, the dollar's lower value should help support U.S. export growth in 2005, a welcome relief for U.S. exporters.
Employment on the rise
The unusually slow recovery in employment during 2002 and 2003 is partially explained by painful structural adjustments within particular industries. But the signs are that the adjustment process appears to be nearing completion, as evidenced by 2004's decline in the size and frequency of mass layoffs as well as the small gains in manufacturing employment during the year.
Nonetheless, the overall improvement in the employment situation in 2004 was relatively modest, suggesting that businesses continued to weigh hiring decisions carefully. Higher energy costs likely played some role in restraining employment this year. By some estimates, higher energy prices reduced real GDP growth by about 0.7 percentage points in 2004. If energy prices ease in 2005, some of the restraint in hiring should also lift.
Fiscal policy deliberations cloud outlook
The approach of Congress and the administration to fiscal policy issues will undoubtedly affect the pace of growth in 2005. The nation's fiscal deficits are unlikely to be erased without adjusting taxes or spending. …