(By Mani) The U.S. economic growth would likely remain in low gear for the foreseeable future, as some key decisions on investment and hiring are put off until visibility improves.
It is widely known that the U.S. financial institutions have manageable direct and indirect exposure to Europe's most stressed economies.
Meanwhile, the drag from Europe's financial crisis will likely worsen during the second half of 2012, which is precisely when uncertainty about U.S. fiscal policy and the upcoming presidential election is likely to be greatest.
However, unfortunately, there is no magic band that U.S., as well as European policy makers, can wave to boost growth and throttle back austerity. Despite Greece elected a pro-bailout party that retains the majority of the austerity measures agreed to during earlier bailouts, Europe's periphery countries are likely to endure a severe recession in 2012 and face a long road to recovery afterward.
"Restoring competitiveness to Greece, Italy, Spain and Portugal will take several years and possibly decades," Wells Fargo economist Mark Vitner wrote in a note to clients.
During this time, the euro zone is likely to stumble from one crisis to another, using any let up in the crisis to help strengthen firewalls that would prevent problems in the periphery countries from spreading to Europe's banking system and larger economies.
The reverberations of Europe's crisis would hurt the U.S. economy, which itself is struggling to improve. The Congressional Budget Office (CBO) recently released its 2012 long-term budget outlook. The report laid out two scenarios. Under the first, or so-called fiscal cliff scenario, all of the tax cuts enacted in 2001 and extended in 2010 expire at the end of 2012, along with a host of other temporary tax breaks including the two-percentage-point reduction in Social Security contributions.
Moreover, the spending cuts mandated by the sequestration resulting from last year's budget impasse take effect. Under this scenario, federal debt held by the public would decline from an estimated 73 percent of GDP this year to 61 percent by 2022 and 53 percent by 2037.
"Unfortunately, the progress in reducing the budget deficit comes at a price. Fiscal policy is exceptionally contractionary, and likely sends the U.S. economy into a severe recession in 2013," Vitner noted.