Outlook for 2013: An Economy On the Mend

Though a better economy is likely in 2013, the gains won’t be clear until summer. So come January, whether Barack Obama again sits in the Oval Office or Mitt Romney ousts him, the sluggish economy will remain a worry. Even dramatic policy shifts -- and they are not likely, whoever is president, given that Congress will remain narrowly divided -- would take time to rev up the economic engine.

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Problem No. 1 is, of course, avoiding a nosedive off the fiscal cliff before year-end, when tough government spending cuts kick in and the lower tax rates of the past decade expire. Deadlock on the issue would spell recession ahead, paring up to four percentage points from GDP growth in 2013. We still expect a deal to buy more time, however, with lawmakers putting off the tough decisions until a new Congress is seated. It will probably give them till spring to act.

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Uncertainty about the fiscal cliff is a significant cloud. Indeed, Mark Zandi, chief economist with Moody's Analytics, says, "The only missing ingredient [for a stronger economy next year] is the political will to address our fiscal issues in a responsible way."

In any case, growth in early 2013 is bound to slow, dipping from a bit better than 2% in the second half of this year to only about 1.5% for the first half of 2013. Tighter fiscal restraints -- whether due to higher taxes, federal spending cuts or both -- will curb gains. Just ending the payroll tax break (a fair bet) would cut about $1,000 from the average household's income, for example, and trim 0.5% from GDP.

Don't look for much lift from overseas demand, either. Europe is likely to remain in a recession through the first half of the year; even powerhouse Germany is flagging. Plus China's slowdown will ripple through Asia. So U.S. export growth will be curbed, held to only about 5% for the year.

A similarly weak 3% bump for business spending is in the offing as well. While job growth and demand remain sluggish, there's little or no incentive for firms to release much of the $1.7-trillion stash they're sitting on to expand factories and offices or to buy new equipment.

As for government's usual contribution to growth, it won't deliver much. Federal lawmakers in both parties agree on the need to rein in Uncle Sam's budget, and state and local governments are just regaining their equilibrium after a very difficult past few years. Though revenues are headed up again, they are in no mood to launch major spending projects.

The need to replace and rebuild after the devastation of Hurricane Sandy is likely to deliver a small upward lift in the first quarter of next year. But it won't be significant, adding perhaps a tenth of a percentage point to growth. Moreover, it will probably only offset a small slide in the fourth quarter of 2012, from the loss of business in the immediate aftermath of the storm.

In the second half of 2013, look for considerably more pep in the economy. As the housing market picks up steam, it will add wealth to the economy and nurture consumer spending. The Federal Reserve will keep mortgage rates near all-time lows, encouraging building and buying. Plus, as the year unfolds, banks will become more eager to make loans, easing an obstacle to residential construction.

By year-end, GDP growth should be chugging along at a much healthier 3% pace, though for 2013 as a whole, another yearly gain in the 2% neighborhood is likely. All told, we expect about 2 million net new jobs, enough to push the jobless rate to about 7.5% and to keep consumer spending on an upward path, albeit a weak one -- no better than this year's 2% gain, maybe less, for this giant chunk of the economy.