The Economy: Four Lessons From 2011 for 2012

Though 2011 is ending on a positive note with stronger growth and lower unemployment, it was a tough year. The economy barely grew for most of it, at a point in past recoveries when growth is usually surging, and that wasn't the only surprise. As we look forward to 2012, here are four things we learned in the last year that inform our view of what's ahead for the economy.

1. In extraordinary times, dependable rules about the economy sometimes don't apply. Since the 1930s, other recessions and recoveries have been roughly symmetrical. The deep recessions in the 1950s, 1970s and 1980s were followed by strong recoveries, and mild recessions in the 1990s and 2001 yielded to modest growth. But this time, the geometry hasn't followed the rule. The explanation is that the Great Recession was driven by a serious financial crisis -- America's first in 80 years. In other countries, where such crises have been more frequent, the related deep recessions are followed by economic weakness that lasts for five to seven years, according to economists Kenneth Rogoff and Carmen Reinhart.

Despite the deep recession, the trend line for 2012 is a very, very gentle slope upward. U.S. gross domestic product will grow only about 2% in the coming year, a little better than in 2011. That will be the first time on record that growth persisted at such a slow pace for two years without the economy falling into a recession.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

2. Fiscal policy matters. A modest package of tax cuts approved in late 2010 likely made the difference between the slow growth that occurred and another recession. Congress pumped about $200 billion into the economy via new tax cuts and unprecedentedly long unemployment benefits. When the books are closed on 2011, that amount will roughly equal the expansion in U.S. GDP over the year. There is no doubt that the payroll tax cut -- leaving about $1,000 more in disposable income for the average working family -- was a big reason that consumer spending grew in 2011. Stimulus that's badly timed or too narrowly targeted can fail, but this one worked well.

Across the Atlantic, the unfortunate effects of contractionary fiscal policy are evident in the United Kingdom. In 2010, the International Monetary Fund predicted that the U.K. economy would grow 2.5% in 2011, much better than the economies of the 17 nations that use the euro, forecast to gain just 1.5%. But the newly elected Conservative-led government of Prime Minister David Cameron imposed steep and immediate budget cuts. As a result, the U.K. economy tanked, and Britain will likely be the only major European economy to shrink in 2011.

Fiscal policy will be crucial again in 2012, in both the United States and Europe. Congress will break the stalemate over extending this year's payroll tax cut by early 2012, largely because the public would correctly blame lawmakers for allowing taxes to rise and endanger the recovery. Voters are weary of the larger stalemate over reducing federal debt, so the leading presidential candidates are likely to focus less on debt reduction plans that won't begin for years and more on growth-boosting plans to create jobs in the near term. And in Europe, someone will notice that Italy's debt emergency is not caused by its budget deficit -- now less than 4% of GDP -- but by its lack of growth. German demands for deficit cutting will yield to demands for stimulus and growth, especially now that Germany's economy is shrinking also.

3. Oil prices still matter, too. It's true that the U.S. economy is much less dependent on energy than it was in the 1970s and 1980s, when price shocks precipitated recessions. And oil prices don't matter much when growth is solid. But in the currently weak recovery, it is no coincidence that economic growth essentially halted in late 2010, when the price of oil started to rise again, climbing from $84 a barrel in November to $110 by April 2011. It's also no coincidence that GDP is bouncing back in the final quarter of 2011, after oil prices have dropped steadily from the summer. A fall in gasoline prices is one of the most direct ways to put money into consumers' pockets, and the moderation in prices surely helped boost stronger-than-expected post-Thanksgiving retail sales.

Although the slowing world economy will reduce upward pressure on oil prices in 2012, there remains considerable risk of a geopolitical shock sending oil prices soaring, as the Arab Spring revolts did earlier this year. Continued conflicts with Iran over its nuclear ambitions are a particular worry. A spike in oil prices would hit already meager consumer spending and could easily turn slow growth into no growth.

4. Emerging economies now drive global growth. Only a few years ago, the kind of abrupt economic slowdown seen in 2011 in Europe and the United States would have brought world economic growth to a halt. But 2011 demonstrated that the United States and other wealthy countries are no longer the only engines pulling the world economy. Developing countries, already premier producers of manufactured goods, have become premier consumers as well. For the first time, imports by China and other emerging economies in 2011 exceeded imports by the developed world.

Strong U.S. exports to the developing world are one reason that a recession in Europe won't derail growth in the United States in 2012. Developing countries will provide the lion's share of global growth, and that will probably continue after the developed world recovers. From now on, the growth rates of China and India will be much more important to America's economic prospects than the growth rates of Germany and Japan.