In 2012, ECB's announcement of a new bond purchase facility, coupled with its liquidity policies, provided breathing space from the crisis. However, markets may not be so kind next year if growth falters, adjustment efforts in the periphery remain under pressure, and negotiations to strengthen the monetary union continue to move at a snail's pace.
A return to growth would provide confidence that reform can be sustained, economic targets met, and debt levels will remain sustainable. Without it, we are likely to see Europe again at the brink.
Mark Thoma, fellow, The Century Foundation
Ever since the double-digit inflation problems of the 1970s, the U.S. Federal Reserve has reacted strongly to any sign of inflation and avoided policies that might lead to hyperinflation. This high degree of sensitivity to inflation appeared to work well from 1984 to 2007, known as the Great Moderation. But when the Great Recession of 2007 to 2009 hit, worries about inflation put a constraint on the Fed's ability to aggressively attack our unemployment problem. In retrospect, the Fed was too timid: With so much slack in the economy, worries about inflation were overblown, and a more aggressive response to the unemployment problem would have been possible.
One of the most important emerging trends in macroeconomic policy is the movement toward central-bank operating procedures that are more tolerant of the temporary increases in inflation needed to effectively fight unemployment in deep recessions. The Fed's recent announcement that it is willing to allow inflation to drift above its 2 percent target as it battles unemployment is an example of this change in thinking. That's a big departure from the Fed's previous policy, by which it appeared unwilling to allow the target inflation rate to be exceeded at all.
This reevaluation of monetary policy in light of the experience of the Great Recession is not limited to the United States. Bank of Canada Gov. Mark Carney, for example, hinted recently that he may employ similar monetary policies when he takes over as governor of the Bank of England in July 2013. While he will still have to persuade others on the monetary policy committee to adopt his views, he was chosen to shake things up, and certainly brings a more dovish outlook to the policy table.
Will this spread to continental Europe as well? Because of the hyperinflation in Germany's history, there is considerable resistance to lowering the European Central Bank's guard against inflation. But if these policies work in the United States and the United Kingdom, as I believe they will, the spread of these new ideas to ECB and beyond is inevitable.
Yukon Huang, senior associate, Asia program, Carnegie Endowment for International Peace
The upcoming year will mark the turning point when 8 percent growth in China is viewed as a welcome norm rather than a disappointment. It will also signal when tensions between the United States and China shifted from recriminations over the value of the renminbi to the barriers inhibiting foreign investment.
Over the past year, markets were fixated on China's economic slowdown given the unrealistic hope that continued double-digit growth might compensate for the problems afflicting the OECD economies. But slower growth will be good for China if it represents a more sustainable path. As a maturing economy, quality rather than quantity of growth is what now matters.
With slackened import demand in the United States and Europe, China's already much reduced trade surplus will continue to decline. The renminbi is no longer significantly out of line, although the United States will probably be the last to acknowledge the new reality.
Currency wars will recede as the source of tension for the two countries, but circumstances will push them to battle over foreign investment and technology transfer policies. This is evident in the recent outcries over security risks as Chinese firms seek greater access to the U.S. market and U.S. firms are pressured to share valuable technologies as the price for accessing China's market.
China is the center of an Asian production sharing network that brings in components from other countries for assembly with export of the final product to the West. But these are low paying assembly jobs, and the priority now is to develop more sophisticated product lines that can generate the better paying positions needed to sustain rapid growth.
Beijing believes that this needs to come through development of "indigenous" technology, as was the case with South Korea and Taiwan. This involves securing the technological expertise either from abroad or developing it locally with or without the involvement of foreign partners. Thus tensions over technology transfer and respect for intellectual property rights will likely dominate discussions between the United States and China this coming year even as the rhetoric over exchange rates moderates.
Mark Zandi, chief economist, Moody's Analytics
Given the incessant brinksmanship in Washington over the nation's fiscal challenges, it isn't hard to be pessimistic about the U.S. economy's prospects in 2013. Under any scenario a retrenching federal government will weigh heavily on growth. But assuming Congress and President Obama do roughly the right thing and strike a deal on the fiscal cliff, the economy will be enjoying healthy growth by this time next year. Housing is set to kick into gear, businesses will invest and hire more aggressively, and consumers will spend with more gusto.
A housing renaissance is already under way. This may be hard to believe after the dizzying six-year-long crash in home sales, construction, and housing prices. But housing turned up this year and it will take off in 2013. The logic behind this optimism is simple: Owning a home has never been so affordable. House prices have been slashed by more than one-third since the onset of the housing bust and mortgage rates have never been lower. The rent-buy decision is also a slam dunk in much of the country as rents continue to rise almost everywhere.
Significantly, U.S. companies lowered their cost structures during the recession, and profit margins have never been wider. Strong profits and low interest rates have allowed firms to substantially lighten their debts and generate a flood of cash. Businesses will soon realize that to keep their earnings and stock values healthy, they need to seek new growth opportunities.
Household finances are less uniformly rosy, but they, too, are much improved. Higher-income households have shed debt, and most have only fixed-rate mortgages that have been made cheaper through refinancing. Lower-income households still struggle to make mortgage and student loan payments, but across all households, the proportion of after-tax income needed to stay current on outstanding debt is approaching record lows. Households aren't likely to ramp up borrowing anytime soon--and lenders are unlikely to give them the opportunity--but most consumers no longer have to curtail spending to manage their debts.
The U.S. economy is one piece of legislation away from a much brighter future.
This article originally appeared at CFR.org
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