Hamish McRae: Lessons for all as America bounces back

America is back.

Do you remember how 18 months ago some self-confident economists predicted that it would be a catastrophe if the US went over the “fiscal cliff” and Congress forced it suddenly to cut public spending? Well, it did and the economy if anything grew faster. And on the other side, an equally self-confident set of economists urged even sharper cuts in spending, without which the budget deficit would fail to close, leaving future generations with an ever-rising debt burden. Well, they were wrong too.

The US fiscal year ends tomorrow. It looks very much as though the outcome will be a deficit of around $500 billion. That is a huge sum of course but it is a huge economy, so this works out at 2.9% of GDP. That is below the 3% ceiling permitted for European countries under the Maastricht rules, and lower than any other G7 country bar Germany and Canada. Notwithstanding our own rapid growth at the moment, we are stuck with a deficit about 5.5% of GDP, and so far this year we are doing a bit worse than we were last.

The confidence that the US recovery is secure and that its national finances are under some sort of control has been reflected in the surge in share prices and the dollar. Shares are within a whisker of their all-time high and the dollar is up 6% in the past three months, the highest since June 2010. Propelling both has been decent growth, with last week an upward revision of the second quarter to 4.6% annual rate. True, this was partly a bounce back from a dreadful first quarter when, thanks to bad weather, the economy shrank. But forward-looking data such as consumer confidence and business surveys point to a strong third quarter too.

The Federal Reserve ends its version of quantitative easing — its monthly purchases of Treasury securities — next month, but the prospect of this does not seem to have fazed the markets. When Fed chairman Janet Yellen hinted that if growth continued strongly, interest rates might rise earlier than people expected, they took that in their stride too. The thing I find most interesting, however, is that contrary to all those fears, the US is getting its national finances under control. How?

It is several things. First, spending is rising a little more slowly than expected. For example, spending on Medicare is lower than projected. Second, financing costs have been held down by very low interest rates, and the Fed has been transferring profits on its holdings of public debt to the Treasury. Third, tax revenues have been generally towards the higher end of the expected range. The outcome will be a deficit that is just about holding steady at around 74% of GDP.

That does not mean the US fiscal position is fine forever. Rates will go up, and financing costs with them. Insofar as any long-range projections mean anything, the Congressional Budget Office projects that the debt will rise to 77% of GDP over the next 10 years. But it is a great turnaround from the concerns of two or three years ago, and somewhat better than our own performance as the Office for Budget Responsibility expects our net debt to rise above 77% this year.

So what does all this mean, aside from the unsurprising fact that economists get things wrong?

I think the overriding lesson is that the US economy has a resilience and depth that allows it to cope with sub-optimal economic policies. Never underrate America. If you are that big, that flexible, that inventive, you can get away with massive mistakes in a way that smaller countries can’t.

The flip side of that holds true too: if you are a small country, you cannot afford to make policy errors — as many fringe European countries have discovered.

A further lesson applies to us too. It is that if you can get decent growth, other things tend to come right — and vice versa. It is not just that the maths of higher growth improves public finances. It will also tend to improve corporate and personal finances, with the former leading to higher investment and job growth, and the latter underpinning consumer confidence and lifting consumption.

The benefits of growth are always unevenly shared, both geographically and socially, so it is not a cure-all. We should always remember that. But without growth, you are really in a jam.

A further and more tentative conclusion is that monetary policy seems to be more powerful than fiscal policy. Tighter fiscal policy does not seem to have held back US growth in the way predicted, while ultra-loose monetary policy has unquestionably driven the recovery.