America is back. Do you remember how, 18 months ago, some self-confident economists predicted that it would be a catastrophe if the US went over the "fiscal cliff" and Congress forced it suddenly to cut public spending? Well, it did and the economy if anything grew faster. And, on the other side, an equally self-confident set of economists urged even sharper cuts in spending, without which the budget deficit would fail to close, leaving future generations with an ever-rising debt burden. Well, they were wrong, too.
The US fiscal year ends on Tuesday. It looks very much as though the outcome will be a deficit of around $500bn. That is a huge sum, of course, but it is a huge economy, so this works out at 2.9 per cent of GDP. That is below the 3 per cent ceiling permitted for European countries under the Maastricht rules, and lower than any other G7 country, bar Germany and neighbouring Canada. Notwithstanding our own rapid growth at the moment, we are stuck with a deficit around 5.5 per cent of GDP and so far this year we are doing a bit worse than we were last year.
The confidence that the US recovery is secure and that its national finances are under some sort of control has been reflected in the surge in both share prices and the dollar. Shares are within a whisker of their all-time high and the dollar is up 6 per cent in the past three months, the highest since June 2010. Propelling both has been decent growth, with last week an upward revision of the second quarter to 4.6 per cent annual rate. True, this was partly a bounce back from a dreadful first quarter when, due to bad weather, the economy shrank. But forward-looking data such as consumer confidence and business surveys point to a strong third quarter, too.
The Federal Reserve ends its version of quantitative easing – its monthly purchases of Treasury securities – next month, but the prospect of this does not seem to have fazed the markets. When Janet Yellen, chair of the Fed, hinted that if growth continued strongly, interest rates might rise earlier than people expected, they took that in their stride, too.
The thing I find most interesting however is that, contrary to all those fears, the US is getting its national finances under control. How?
It is due to several things. First, spending is rising a little slower than expected; Medicare spending, for example, is lower than projected. Second, financing costs have been held down by very low interest rates, and the Fed has been transferring profits on its holdings of public debt to the Treasury. Third, tax revenues have been generally towards the higher end of the expected range. The outcome will be a debt that is just about holding steady as a percentage of GDP, at around 74 per cent.
That does not mean that the US fiscal position is fine forever. Rates will go up and financing costs with them. If long-range projections are worth anything, the Congressional Budget Office projects that the debt will rise to 77 per cent of GDP over the next 10 years. But it is a great turnabout from the concerns of two or three years ago and somewhat better than our own performance as our net debt is expected by the Office for Budget Responsibility to rise above 77 per cent this year.
So what does all this mean?
I think the overriding lesson is that the US economy has a resilience and depth that allows it to cope with sub-optimal economic policies. Never underrate America. If you are that big, that flexible, that inventive, you can get away with massive mistakes in ways that smaller countries can't. The flipside of that holds true, too: if you are a small country you cannot afford to make policy errors.
A further lesson applies to us, too. It is that if you can get decent growth, other things tend to come right – and vice-versa. It is not just that higher growth improves public finances. It also tends to improve corporate and personal finances, with the former leading to higher investment and job growth, and the latter underpinning consumer confidence and lifting consumption. The benefits of growth are always unevenly shared, so it is not a cure-all. But without growth you really are in a jam.
A further and more tentative conclusion is that monetary policy seems to be more powerful than fiscal policy. Tighter fiscal policy does not seem to have held back US growth in the way predicted, while ultra-loose monetary policy has unquestionably driven the recovery. We are too close to events and there are a string of further unanswered questions, including the great puzzle as to why the English-speaking countries are growing faster than the Continent and Japan. But for the moment, let's welcome the fact that the US economy and its public finances are both very much on the mend.Reuse content