Academic journal article National Institute Economic Review

Effects of Risk Premia Falling below Sustainable Levels in the US

Academic journal article National Institute Economic Review

Effects of Risk Premia Falling below Sustainable Levels in the US

Article excerpt

The outlook for the US economy has improved modestly compared to our projections three months ago. This can be attributed largely to the unexpectedly rapid decline in risk premia, while the recovery in world trade appears to be being led by Asian markets, allowing a positive contribution to US growth from net trade in the short term. After a cumulative decline in output of 3.8 per cent in the US in the year to the second quarter of 2009, GDP probably recorded a rise in the third quarter, supported by a rise in consumer spending and a positive impact from net trade. We expect output to decline by 2.8 per cent in 2009 as a whole, and forecast a rise in US GDP of 1.3 per cent in 2010.

Consumer spending was 1.3 per cent higher in August compared to three months earlier, supported by the Car Allowance Rebate System, which provided rebates to exchange fuel inefficient cars for more efficient models.

The strong impact this has had on consumption is shown by the rise in spending on durable goods of 8.9 per cent in August relative to three months earlier. The programme ended at the end of August, and consumer spending probably dropped back somewhat in September as a result. However, the American Recovery and Reinvestment Act includes a wide range of measures that support personal disposable income, including one-off social security payments, an increase in unemployment benefit and an increase in benefits through the former food stamp programme. Spending on non-durables and services also increased in August, suggesting that some of the longer-term stimulus measures have also been effective in sustaining consumer spending. We forecast a rise in consumer spending of 0.8 per cent in 2010, following a decline of 1/2 per cent in 2009.

Exports also recovered in the third quarter of 2009, after a cumulative decline of 15 per cent in the year to the second quarter. In July and August, the volume of goods exports was 5.2 per cent higher than three months earlier, with a strong recovery in car exports in particular. Goods imports also increased in July and August, but, with a rise of just 3 1/2 per cent, net trade appears to have made a positive contribution to GDP growth in the third quarter. The source of recovery in external demand appears to stem from Asia, as the value of exports to China, South Korea and India increased by more than 5 per cent in the second quarter of 2009 (on a seasonally unadjusted basis). In 2009 as a whole, net trade is expected to make a positive contribution to GDP growth, thanks to a revival in demand from Asia.

However, in 2010 US domestic demand is expected to strengthen and we anticipate a small negative contribution from net trade.

In addition to the revival in consumer spending and exports, we anticipate a modest turn in the inventory cycle. The ratio of business inventories to sales has receded from the peak reached in December 2008, and it appears that the bulk of the necessary inventory correction has been achieved. However, the inventory to sales ratio remains higher than the average level in 2007. Consequently, although we do not expect a strong rise in inventory accumulation, the rate of destocking should ease over the next few quarters. We estimate that destocking reduced GDP growth by 0.7 percentage points in 2009, but stockbuilding is expected to add 0.4 percentage points to growth in 2010 as the rate of destocking moderates.

Labour market conditions, however, remain bleak. The unemployment rate has risen to its highest level since 1982, a rise of over 5 percentage points since early 2007. Real wages also declined steadily in the first eight months of 2009, indicating that many of those who have retained their jobs have done so at a cost, accepting wage cuts to stave off unemployment, and the combined impact of falling wages and rising unemployment has severely affected labour income. We expect the unemployment rate to reach 10 per cent in 2010, but begin to decline in 2011. …

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