Abstract
This staff report on United States 2013 Article IV Consultation highlights economic policies and development. The economy grew at an annual rate of 1.8 percent in the first quarter of 2013, held down by sharp cuts in public spending, and economic indicators suggest that growth has remained weak in the second quarter of the year. Employment gains averaged about 200,000 over the first half of 2013, up from 180,000 in the previous six months. The unemployment rate continued to fall from its October 2009 peak of 10 percent to 7.6 percent in June 2013, although much of the improvement reflects lower labor force participation.
1. This note reports on information that has become available since the staff report (SM/13/197) was issued and does not alter the thrust of the staff appraisal.
2. Recent indicators point to a sharper than expected slowdown in economic activity in the second quarter. This reflects weakness in inventory accumulation and net exports as well as slower private consumption growth, as suggested by retail sales in June. On a positive note, recent housing indicators (such as the homebuilders’ survey) remain relatively upbeat, despite the recent rise in mortgage rates, which has slowed refinancing activity. Headline inflation picked up to 1.8 percent (y/y) in June, mainly due to an increase in gasoline prices, while core inflation inched down to 1.6 percent.
3. U.S. and global financial markets have somewhat stabilized after the correction in June. In the United States, financial conditions have improved since early July, with slightly lower long-term Treasury yields and mortgage rates, narrower risk spreads, higher stock prices, a weaker dollar against most major currencies, and lower volatility. However, trading liquidity remains low across a number of markets and outflows from long-term U.S. and emerging market bond funds have continued, albeit at a slower pace. Global equity markets have partly recovered the losses experienced since late May (on July 18, the MSCI for emerging markets was still about 10 percent down relative to May), while emerging market domestic government bond yields and external bond spreads have declined from their peak in June. Second-quarter earnings for major U.S. financial institutions were mostly above expectations, mainly driven by higher trading and investment banking revenues. In his testimony to the House of Representatives on July 17, Chairman Bernanke appropriately reiterated that the pace of asset purchases depends on the performance of the economy, and that the current pace could be maintained for longer if financial conditions were judged to be insufficiently accommodative.
4. The Mid-Session Review (MSR) released by the Office of Budget and Management (OMB) on July 8 confirms the progress in deficit reduction. OMB’s projection of the federal deficit for FY2013 is now 4.7 percent of GDP, well below the projection in the President’s Budget (6 percent), reflecting stronger-than-expected revenues, a one-off payment from Fannie Mae and Freddie Mac,1 and the fact that the sequester is now assumed to remain in place through FY2013. Growth projections were revised down (and are now closer to staff projections), and this slightly increases the projected deficits in the outer years.
5. More progress was achieved on the financial reform agenda. On July 8 the Financial Stability Oversight Council (FSOC) designated two non-bank financial institutions, American International Group (AIG), and GE Capital, as systemically important. Prudential Financial has appealed the proposed designation by the FSOC. Markets’ reaction to the designations has been fairly muted, with shares of the designated firms generally rising in line with the broader equity market. On July 9, The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a notice of proposed rulemaking that would introduce an enhanced supplementary leverage ratio of 6 percent for the largest 8 U.S. banks. On July 11, the Commodity Futures Trading Commission and European Union regulators announced an agreement on derivative regulations which seeks to harmonize cross-border rules, by allowing swap market dealers and participants to be subject only to the relevant rules of domestic authorities.
6. The Bureau of Economic Analysis (BEA) is scheduled to release a comprehensive revision to the national income and product accounts on July 31st, together with the first estimate of GDP growth in the second quarter of 2013.
The two companies had written down the value of deferred tax assets during the crisis, given the bleak outlook for the housing market. In May 2013, they decided to reverse the write-downs as they returned to profitability. This boosted the net worth of the companies and increased the dividends payable to the Treasury under the bailout agreement. These payments (of about $85 billion) are included in the budget on a cash basis, but are not included in staff’s estimates of the fiscal deficit which are on an accrual basis, in line with GFSM 2001.