POLITICS: PennAve

Economic outlook rosier than 2013, but concerns remain about overheated markets, Iran

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Jobs,Iran,PennAve,Joseph Lawler,Economy,Federal Reserve,Inflation,Europe

The economic outlook for 2014 is brighter than it was for 2013.

The growth in the gross domestic product has accelerated to 4.1 percent in the most recent quarter, despite 2013's tax hikes and sequester spending cuts that were predicted to slow commerce. U.S. businesses added 2.3 million jobs over the last year, and the unemployment rate fell from 7.8 to 7 percent.

But with the nation 8 million jobs short of full employment, the economy clearly isn't healthy. And forecasters, the Fed in particular, have consistently overestimated the strength of the recovery since 2009.Federal Reserve officials expect the economy to average roughly 3 percent growth throughout 2014, and for the unemployment rate to dip as low as 6.3 percent — not far from the Fed's estimated "normal" rate of roughly 5.5 percent.

The biggest risk to the economy in 2014 might be a bubble similar to the housing and dot-com bubbles.

The Fed has aimed to boost asset prices with its monetary stimulus programs. With a balance sheet of about $4 trillion and hundreds of billions of dollars in additional bond purchases likely in 2014, the possibility of overheating markets is a concern.

Fed Chairman Ben Bernanke acknowledge the concern in his December press conference, saying, “I don't think that you can completely ignore financial stability concerns in monetary policy because we can't control them perfectly.” But he added that the central bank was on track to phase out the purchases, a process it began last month, before markets became “bubbly.”

Nevertheless, Robert Shiller, the Yale professor who won the Nobel Prize in October for his research on financial bubbles, warned in December that valuations were moving away from fundamentals.

“I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable,” Shiller said, noting that he wasn't yet “sounding the alarm.”

Shiller’s cyclically adjusted price-to-earnings ratio for the S&P 500 is now roughly 26. Shiller identifies a ratio above 28.8 percent as danger territory.

But some analysts shrug off bubble fears, instead worrying more about threats from outside the U.S., such as continued economic weakness in the euro zone and political unrest in the Middle East.

Deutsche Bank economist Joseph LaVorgna wrote in December that “for us, the risk to growth is to the upside, not the downside. Beyond this, the primary downside risk in 2014, as it is in most years, is geopolitical, meaning we get some sort of negative exogenous shock such as an oil price spike.”

The Eurasia Group research firm said in a January report on economic risks that if U.S. diplomacy with Iran over its nuclear program fails, “a pronounced spike in the oil price would result, with investors fearing military strikes and Saudi proliferation adding to geopolitical tensions…”

But there are fewer obvious traps facing the economy in 2014 than there were, for instance, in 2010, when then-Treasury Secretary Timothy Geithner wrote an New York Times op-ed in August trumpeting the beginning of a recovery, right before growth tanked again partly because of Europe's struggles.

One major threat is off the table, namely the possibility of further fiscal retrenchment by the government. Obama administration officials say they aren't seeking further tax rate increases, and congressional Republicans are content to protect the sequester cuts rather than seek new ones. The economy weathered 2013's fiscal tightening fairly well even though the Congressional Budget Office projected that the cuts would lower growth by 1.5 percentage points.

Another downside risk, that of political disruptions, also appears to have receded for 2014.

Analysts and lawmakers point to the budget agreement between Democrats and Republicans as evidence that another government shutdown is unlikely.

And although another standoff over raising the federal debt ceiling in late February or early March remains possible, investors showed in October and in 2011's close call that they can withstand congressional drama.

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