As we put 2011 behind us and embark on a new year, the question on everyone’s mind is, What will the pace of growth look like in 2012? Will it proceed at a brisk pace as it did in 2010 when the economy came back to life following the recession and grew 3.0% over the year? Or will growth more closely resemble the pace in 2011 when the recovery fell into a slow patch and growth fell below its potential rate, growing at what we believe will be a bit under 2.0%?

Before moving on to the outlook for 2012, it’s worth taking a quick look at the year that was. The economy grew at a paltry 0.8% growth rate in the first half of 2011 due to a series of one-off events, including rising oil prices during the Arab spring uprisings, the fallout from the earthquake and tsunami in Japan, and flooding in the Midwest. Following these events, growth gradually picked up again in the second half of the year as real GDP grew at an annual rate of 1.8% in the third quarter. Fourth-quarter GDP data will be released by the time this article hits the presses, but at the moment, incoming monthly data are pointing to stronger growth in the fourth quarter, with many forecasters expecting 3½% or better.

A Late Surge
The expected fourth-quarter spurt is the result of stronger consumer spending and a modest amount of inventory rebuilding. It appears that the holiday shopping season was pretty strong this year with December chain store sales up 3.5% over a year earlier, according to the International Council of Shopping Centers, and monthly consumption data for October and November increasing at a 1.9% annual rate. The second positive development in the fourth quarter is a pickup in private inventories. Inventory investment is expected to add a bit under $15 billion in the fourth quarter, offsetting a $2 billion decline in the previous period. We do not expect additional investment however, so the positive impact in Q4 will dissipate in future quarters.

Another promising trend in 2011 was the resumption of bank lending to business. Commercial and Industrial (C&I) loan lending turned positive in 2011 after credit markets tightened up during the recession. Even in 2010, as the broader economy improved, bank lending to businesses continued to decline. But at the start of 2011, lending turned positive and grew at a brisk pace over the course of the year. C&I loans increased at an annualized rate of 15.1% in October and 5.9% in November.

Another sign of improvement in 2011 was the increase in corporate profits. Profits, which plunged during the recession, have now risen above prerecession levels. With higher profits, improved access to capital, and improving business confidence, we expect business activity to continue to improve in 2012.

Boosted in part by ongoing tax incentives, investment in equipment and software was one of the stronger contributors to GDP growth in 2011. Equipment and software investment rose at a 16.2% annual rate in the third quarter after growing 6.2% in the second and 8.7% in the first. We expect that the pace dropped off slightly in the fourth quarter and will stabilize at around 7.0% over the next year. 

While investment in equipment and software should remain relatively solid over the next year, we will get less of a boost from investment in structures. Structural investment grew at an annual rate of 14.4% in the third quarter after growing at a blistering 22.6% pace in the second quarter. We expect the pace to slow to no more than the mid-single digits in 2012.

One other significant trend over the past year has been the improvement in net exports as a result of the weaker dollar and a reduced demand for imports. Export growth was not particularly strong this past year as the world economy slowed, but our demand for foreign goods fell off sharply. Imports rose only 1.2% in the third quarter and only 1.4% in the second quarter. As consumption continues to gradually pick up in 2012 and with the dollar now strengthening, we expect imports to increase and export growth to wane and our trade balance to deteriorate again.

Hope for the Labor Market
Our forecast for stronger growth in the fourth quarter is consistent with the faster pace of job growth we’ve experienced over the past few months. Since September, when the pace of job creation first accelerated, the economy has generated an average of 156,000 net new jobs per month. By contrast, in the first eight months of the year, the economy created an average of 127,000 jobs per month. This highlights how dependent our labor market is on solid, sustained economic growth. 

The faster pace of job growth has been one factor affecting the unemployment rate, which dropped from 9.1% in August to 8.5% in December. Another important factor has been the decline in the labor force participation rate, which has declined 2.0 percentage points since the beginning of the recession. How the unemployment rate fares this year will depend on these same factors—economic growth and the participation rate. If the participation rate rises as discouraged workers and others not counted in the workforce reenter the labor force, we might see the unemployment rate rise for a period even with solid economic growth. Our best guess at this point is that growth and changes to the participation rate will lead to a sticky unemployment rate this year.

Downside Risks to the Outlook
Our economy is currently showing signs of strength, and we are guardedly optimistic about continued positive growth this year. After strong growth in the fourth quarter, we expect the economy to drift back to a 2½% growth rate through the first half of the year. The economy should gradually improve in the second half to about 3.0%. Our forecast is predicated on two major assumptions.

The first assumption involves developments in Europe. The continuing debt troubles in the eurozone have already lowered the growth forecasts for the region, which is likely already in a modest recession. There are two important implications from this development. First, there is a risk that financial contagion will spread beyond Europe’s borders. We have seen a modest increase in the Ted Spread—the difference between the three-month Libor and three-month Treasury securities—but so far there has been little spillover into our financial markets. The second risk is that the debt crisis will dampen the real economy. The EU is a major market for U.S. exports, and a slowdown in demand abroad could reduce our growth prospects, as well as diminish prospects for the rest of the world.

Another problem for the U.S. outlook is the overhang in the housing market. The pace of new and existing home sales has stabilized recently, but we need considerably faster sales growth to work through our backlog of inventory. One bright spot in the housing market was the recent upturn in housing starts, which rose over 9.0% in November. If prices stabilize in 2012 and demand strengthens, we might finally start to see some improvement in the housing market toward year-end .

Despite considerable uncertainty, we believe that the natural resiliency of the economy, together with some sensible policy and a bit of good luck, can keep us moving in the right direction.
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Brian Higginbotham, U.S. Chamber economist, is the primary author of this article.