Updated Economic Forecast 2012-2013

I expect economic growth better than we've had the past few quarters, back up to the pace that we enjoyed in early 2010. Serious risks from Europe mean that business leaders should do some economic contingency planning, which I address below.

The main thrust behind this resumption of decent growth is QE2, the Federal Reserve's second round of quantitative easing. Although QE2 is over, monetary policy operates with a time lag, so we're just about ready to feel it. As the economy gains ground, consumer and business spending continue to grow, getting us back to a self-sustaining path.

This is NOT an optimistic forecast; I think it's pretty dang moderate. Here's a comparison of my forecast of GDP levels with the CBO's estimate of potential GDP:

With this moderate pace of economic growth, the Fed will certainly keep short-term interest rates low.  Continued growth in the world economy will push up demand for credit, pushing long-term rates up by about two percentage points in two years, so the 10-year treasury will end 2013 around four percent. Inflation will drop because of the large gap between actual output and potential output. The dollar will continue to fall, probably averaging six percent decline per year. Unemployment comes down very slowly, to about 7.5 percent at the end of 2013. That's still too high, of course.

Risks to the Economic Forecast

Risks center on Europe, of course, but don't neglect the possibility that Asia will experience a significant growth slowdown next year or in 2013.

For corporate planning, I recommend the following weights:

60% probability for a mainstream forecast such as my own or the consensus (like the Philadelphia Fed's Survey of Professional Forecasters).

30% probability of a recession centered on exports due to the European crisis.

10% probability of stronger growth than any currently predicts, due to QE2 kicking in especially well, triggering business spending to expand capacity.

For help planning, you might want to review my thoughts on the effects of recession on a business plan or the more general Strategic Planning and the Economy.