WASHINGTON (Reuters) - Famed U.S. economist Milton Friedman once observed that a recovery from recession is like plucking a guitar string: The harder the economy is pushed down, the faster it snaps back.
That didn’t happen when America began to exit a deep downturn in 2009. Now, though, after years of paltry growth and despite a government austerity drive that could batter the economy for months, signs are emerging that a more robust recovery is around the bend.
The main reason is an improvement in household finances, which by some measures are looking more solid than they have in decades. This is allowing consumers to ramp up purchases of homes and cars, the sort of spending that usually leads an economic rebound but that until recently had been held back by heavy debts and tight credit.
“We finally are getting something that looks more like a normal recovery,” said Nigel Gault, an economist at IHS Global Insight in Lexington, Massachusetts.
This hint of normalcy suggests the slow improvements in the labor market over the past few years can now provide a bigger boost to consumer spending, which will in turn create more jobs.
Gault and others expect this increasingly self-reinforcing cycle will lead growth to pick up substantially by the end of the year, even if Washington goes forward with $85 billion in budget cuts scheduled to begin on Friday.
Economists polled by Reuters this month predicted the economy will expand at a 2.8 percent annual rate in the fourth quarter, up from the 1.8 percent rate expected in the first quarter, when higher tax rates enacted in January are expected to hit growth temporarily.
If the forecasters are right, the fourth-quarter performance will mark a big improvement from the average annual rate of 2.1 percent clocked since the end of the recession. Better still, most analysts expect further acceleration in 2014.
Of course, economists have predicted for several years that stronger growth lies just a few quarters away. As 12 million unemployed workers can attest, that hasn’t panned out.
Yet there are several reasons to think this time really is different.
First, a pickup in hiring last year has helped families earn more money. Economists at Goldman Sachs estimate wages and salaries grew by almost 3 percent in the 12 months through December, even when factoring out inflation and unusual payments made to help workers avoid January’s tax increase.
That’s about twice the growth rates clocked in mid-2012, and might explain why higher taxes appeared to take only a small bite out of retail sales last month.
Second, families may be turning a corner in their long struggle to reduce their debt burden. A housing bubble that burst in 2006 left Americans awash in debts taken on during the boom. It also set off panic on Wall Street. Many analysts believe the bust left behind scars that made the recovery weaker than a normal rebound. Even rock-bottom interest rates didn’t persuade debt-shy consumers to spend more, while banks were hesitant to lend.
But slowly, households have reduced their debts by either defaulting or taking out fewer loans as they pay off existing ones. At the same time, incomes have grown and the Federal Reserve has kept borrowing costs exceptionally low. By the third quarter of last year, U.S. household debt payments were 10.6 percent of their after-tax income, the lowest ratio since 1983 and down from a record high 14.1 percent in late 2007. A wider measure of financial obligations that includes rent has also slowly declined and stands at its lowest since the mid-1980s.
Economists at Deutsche Bank project outstanding household debt relative to income will be back in line with its long-term trend by mid-2014. That could once again make consumers more comfortable about borrowing.
Already, areas of spending that usually respond to low interest rates have become the brightest spots in the economy, a sign the recovery is assuming a more normal path.
The pace of auto sales in January would have Americans buying 15.3 million vehicles a year, just below pre-recession levels. In 2012, auto sales were the highest in five years.
The surge has led Michigan Precision Swiss Parts, which makes fuel-system components for Ford and Navistar engines, to expect its sales to climb by 8 percent to 12 percent this year.
“We’re busier than hell,” said Gerald Meldrum, chief executive officer of the company, which is based in St. Clair, Michigan.
Steam is also gathering in the housing market. Home builders large and small are reporting big gains in new orders as prices rise and the supply of homes on the market dwindles. In January, the inventory of existing homes fell to a 13-year low.
“We think the market has taken on a recovery,” said Mark Gray, a vice president of Quadrant Homes, a builder in Bellevue, Washington.
Home building added to economic growth last year for the first time since 2005 and is seen giving a bigger boost in 2013.
“Early cycle indicators like housing now look like they typically do in the early stages of a recovery,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank in New York. “The economy could definitely surprise to the upside this year.”
The next few months could nevertheless be rough.
Executives from retail giant Wal-Mart and restaurant companies such as Olive Garden owner Darden Restaurants warned last week that higher taxes have hurt customers’ spending power.
The scheduled federal budget cuts already have government agencies planning to slash the workweeks of hundreds of thousands of workers. This could shave half a percentage point from economic growth in 2013, and gross domestic product is seen growing just 2 percent in the full year.
Even after the austerity shock recedes, nobody is expecting a boom. Housing remains a smaller share of the economy than it was before the bubble years, so its ability to pump up growth is smaller as well. Credit is still hard to come by, especially for the millions of Americans who defaulted on their debts during the recession. Europe’s debt crisis and higher gasoline prices also pose constant threats to the recovery.
But the improvement in household finances means underlying momentum in the economy might continue to gather. Increased home construction should boost demand for materials made by factories, which are also getting help from a boom in U.S. oil and gas production.
All told, this year’s austerity-bound growth should morph into a beefier rate of at least 3.3 percent in 2014, according to respected forecasting firm Macroeconomic Advisers. That would be the fastest pace in a decade.
After years in which the lingering effects of the housing bust dampened the recovery, the guitar string is starting to make a more familiar sound.
Reporting by Jason Lange; Additional reporting by Michelle Conlin in New York and Paul Lienert in Detroit; Editing by Dan Burns and Douglas Royalty