The headache some folks wake up with on Jan. 1, 2013, most likely will be the result of New Year’s Eve over-indulgence rather than a precipitous fall over the mythical fiscal cliff.
“How the fiscal cliff is resolved has a bearing on both near-term growth and long-term debt,” says Chad Wilkerson, Oklahoma City Branch executive and economist for the Federal Reserve Bank of Kansas City.
But that so-called cliff is neither as precipitous nor as close as some would have us believe, Wilkerson said during the third annual Rural Economic Outlook Conference held on the Oklahoma State University campus in Stillwater.
He said recent descriptions of the mandatory tax increases and spending cuts scheduled to go into effect in 2013—failing congressional action before year’s end—as more slope than cliff makes sense. Not all of the mandated cuts will occur on Jan. 1.
“The process will roll out throughout 2013,” Wilkerson said, “with the biggest hit occurring in the second quarter.”
Uncertainty about how Congress will address those mandatory cuts “are weighing heavily on the economy,” however, and Wilkerson says negotiations have begun to seek a solution to the stalemate. Failure to act likely will result in another recession and increased unemployment.
“Economic forecasters generally assume the fiscal cliff will be avoided without recession,” he said. But he also noted that if all the tax increases and spending cuts scheduled occur, GDP could drop by 4.5 percent.
The Congressional Budget Office projects that unemployment would rise 1 percent “if we go over the fiscal cliff,” Wilkerson said.
Over the long-term, however, allowing the fiscal cliff to play out, accepting both the tax increases and the spending cuts, would reduce the budget deficit over the next 10 years.
“Avoiding fiscal changes,” Wilkerson said, “means further increases in the national debt.”
Some areas, such as unemployment, likely will get better, Wilkerson said. “At its September meeting the Federal Open Market Committee, the branch of the Federal Reserve Board that determines the direction of monetary policy, indicated that unemployment will improve “gradually.” The range of views of FOMC members about monetary policy includes relatively wide variations.
He said some improvement in the U.S. economy has already begun but at a slow pace. “The U.S. economic growth has been moderate,” he said, “as European and political concerns remain high. U.S. gross domestic product (GDP) rebounded somewhat in quarter three but business investment and exports weakened.”
Sluggish growth typical
This sluggish growth is typical “coming out of a financial crisis. Consumer spending is rising but not quickly.”
Early fourth quarter data suggest “moderate U.S. growth to continue.” Residential housing has improved but “recovering at a low level.”
Financial stress in Europe continues to remain high but has improved. “The European economy has not settled as much as the U.S. economy. The United States has settled some in the last few months.”
Inflation rate is expected to remain “at or near its long-term target through2015,” Wilkerson said. The Fed’s inflation target is 2 percent.
More than a third of FOMC members disagree on the timing of monetary tightening. Wilkerson said some expect tightening to increase in the next few years with interest rates moving up to 4 percent. Others expect rates to remain close to zero until unemployment gets close to normal.
Wilkerson said Oklahoma’s economy has fared better than the national economy and “has outperformed just about every other state since last year. Many areas of the state have returned to full employment and most industries are growing. However, energy activity has begun to slow; the fiscal cliff looms; and the drought lingers.”
Job growth rate is widely variable across the country. With a 2.5 percent growth rate Oklahoma is second only to North Dakota. New Mexico, on the other hand, is number 50 and is “one of the most dependent on industries that sell to the Federal government.”
The defense industry is also important to Oklahoma and “is vulnerable,” Wilkerson said. “State unemployment is low but would be higher with more labor force participation.” Northwest and south central Oklahoma unemployment rates are especially low, at or near full employment.
“Growth in energy jobs slowed in quarter three but other industries posted positive growth.”
Oklahoma is not overly vulnerable to European trade risk. The fiscal cliff risk is about average. “Severe to exceptional drought is still gripping the state and the region,” Wilkerson said, putting a clamp on agricultural enterprises. Even with a historic drought, however, observers expect the U.S. farm sector to do well this year. “Total U.S. farm income is projected to rise, given high crop prices and insurance,” he said.
Livestock producers, however, will continue to be “squeezed by high feed costs.”
For lenders, agriculture remains a good bet, he said. ‘Ag loans are more current than any other type of loan at Oklahoma banks. And ag loans are much more important to Oklahoma banks than they are across the nation.”
Regional farmland prices continue to surge “and have accelerated in Oklahoma.”
Wilkerson said recent U.S. economic growth “has been moderate, with low inflation.” The fiscal cliff and concerns over the European economic situation continue to weigh on economic activity.
In Oklahoma, he said, “economic activity remains relatively solid, but drought and low natural gas prices have hurt recently.”
The economy, for Oklahoma and the Southwest region, as well as the nation as a whole, is making progress but some headaches may continue until Congress makes changes in fiscal policy and Europe’s economy settles down. But the Jan. 1 cataclysm may not be the doom and gloom some have predicted.