Is the Economy Set to Take Off? Factors to Watch

Economic forecasters are counting on 2014 to be a breakout year. But whether the economy finally moves past its sluggish growth will rest on several forces playing out differently than they have since the recovery began. Some of the key questions:

1. Will businesses finally shed their caution?

A devastating financial crisis led business owners and corporate executives to be especially wary about adding staff or investing in new equipment. Some worry about risks from Washington or overseas. Others are seeing consumers maintain their slow-but-steady spending, providing little incentive to deploy their cash stockpiles.

As a result, business investment in key areas such as equipment has been historically weak for a U.S. recovery. A slowly improving jobs picture and rising household wealth could spark a virtuous cycle of stronger consumer spending, increased business confidence and rising investment. If it doesn’t, the year could be another letdown.

2. Will Washington’s tentative truce continue?

The December budget deal was hardly the kind of confidence-boosting agreement Washington has been debating for years. But at least it hit the pause button on the serial brinkmanship that threatened to derail the recovery in the past three years.

A combination of tax increases and spending cuts in 2013 shaved about 1.5 percentage points off annual economic growth, according to the Congressional Budget Office. Many forecasters expect the fiscal drag in 2014 to be one-third that amount, or less. “You’ll have more political certainty this year,” said Gregory Daco, a U.S. economist at Oxford Economics.

However, some lawmakers already are discussing a standoff again in late February over raising the federal borrowing limit. “You can never count on policy makers to not shoot themselves in the foot,” Mr. Daco said.

3. Will the Fed’s path out of bond buying get bumpy?

The Federal Reserve last month laid out a timetable to slow the pace of its bond purchases throughout the year. The central bank, which had been soaking up $85 billion a month in Treasurys and mortgage-backed securities since late 2012, plans to reduce the pace of purchases by $10 billion at each meeting until it is no longer buying bonds at year-end.

Few of the Fed’s forecasts have proceeded according to plan during the course of the sharp economic downturn and choppy recovery, a fact that Fed officials now openly acknowledge. “We have been disappointed in the pace of growth, and we don’t fully understand why,” Fed Chairman Ben Bernanke said at his final news conference last month.

The central bank last year spent more than six months signaling its intent to wean the economy off a third round of bond buying, and the prospect upset markets at just about every turn. Now it’s only in the first stage of that process. Even if the tapering is smooth, the Fed could spend much of the year grappling with the prospect of raising its interest-rate target as early as 2015.

4. Will housing adjust easily to higher interest rates?

The housing sector started last year on a high note. It ended the year facing mounting worries about higher interest rates, supply constraints, tight credit and a host of other problems.

Sales of previously owned homes have slipped every month since July, according to the National Association of Realtors. That coincides with the surge in borrowing costs across the economy amid the Fed’s signals about its bond buyingprogram.

Lawrence Yun, the trade group’s chief economist, expects the average 30-year fixed-rate mortgage to hit 5.5% at year-end, up from 4.5% late last year and 3.5% in the first half of 2013. That is a sharp run-up in a short period of time, one that could harm affordability and spook even more buyers.

5. Will the rest of the world cooperate?

Once the U.S. economic recovery started in 2009, other parts of the world began to struggle in their own ways.

Europe fell into a debt crisis. Japan faced a natural disaster. Emerging markets, once the bright spots on the global landscape, lost their glow. Political crises from Italy to Egypt to Thailand raised the prospect of more global unrest.

The world got by in 2013 with fewer confidence-shaking moments than in prior years, but the vulnerabilities haven’t disappeared. “It’s not a great story anywhere, though it’s more hopeful than it has been,” said Jerry Webman, chief economist at OppenheimerFunds.

The relatively stable global outlook must continue if 2014 is to be the kind of economic year Americans have been hoping for throughout the recovery.

Write to Sudeep Reddy at sudeep.reddy@wsj.com