Economists raise forecasts for 2011 US growth

By Robin Harding in Washington

Published: December 7 2010 18:29 | Last updated: December 7 2010 18:29

The proposed fiscal deal between Republicans and Democrats will provide a big boost to growth in 2011 because the compromise gives both parties what they wanted and adds the cost to the deficit.

The result is an extra fiscal stimulus of $1,000bn during the next two years rather than letting the Bush-era tax cuts expire.

Economists expected some or all of the cuts to be kept, but a big surprise is the 2 per cent cut to employee payroll taxes for 2011 that Barack Obama, president, extracted from Republicans, that will save about $2,000 for some families.

“In all, this proposal would add $185bn in stimulus in 2011 beyond what we have been assuming, not including the corporate tax provisions,” said economists at Goldman Sachs.

That extra purchasing power is enough to prompt economists to make substantial upgrades to next year’s growth forecasts.

“We estimate the package will add 0.3 percentage points to GDP growth in 2011 and 0.2 percentage points in 2012,” said Bricklin Dwyer, economist at BNP Paribas in New York.

Michael Feroli of JPMorgan said the boost to consumption would lift his 2011 growth forecast from 3 per cent to 3.5 per cent.

The added short-term stimulus will reduce the chances that the Federal Reserve has to expand on its $600bn programme of asset purchases next year, but is unlikely to cut it short. The Fed’s outlook for 2011 was already more optimistic than that of many market forecasters.

The Fed has called for more spending now, combined with action to reduce the medium-term deficit. Having got the first, it will eagerly await progress on the second.

The biggest part of the package is extending the Bush-era tax cuts for all income groups at a cost of about $800bn during the next two years. Including the highest earners will increase consumption only modestly, because they tend to save extra income, but may add 0.2 percentage points to growth next year.

The payroll tax holiday will cost about $120bn and should provide a reasonable boost to consumption because it is spread across the income range.

The deal cuts taxes on individuals, however, rather than employers, so it will benefit those already in work rather than directly encouraging companies to create new jobs.

Finally, the deal extends unemployment insurance throughout 2011 at a cost of $60bn, and extends increases to tax credits included in the 2009 stimulus.

Unemployment insurance tends to provide highly effective stimulus as the jobless spend almost every cent. Although most economists had assumed some sort of extension, many did not expect a full year.

The cost of the proposal is it adds heavily to the deficit. Mr Dwyer said it would increase it from an estimated 8.5 per cent to 9.5 per cent of gross domestic product in the 2011 fiscal year and from 6.9 per cent to 9.8 per cent of GDP in 2012.