May 19, 2024

Economic Scene: A Mission Not Yet Accomplished

For the second straight year, the recovery seems to be at risk of stalling. The economy grew at an annual rate of only 1.8 percent last quarter — eerily similar to the 1.7 percent growth last spring, just when job growth started slowing down. Fully 80 percent of people say the economy is in fairly bad or very bad shape, according to a New York Times/CBS Poll last month. More people say it’s getting worse than getting better, the opposite of a few months ago.

White House advisers and Ben Bernanke, the Federal Reserve chairman, argue that the bad news is a merely a blip caused by bad weather, a temporary cut in military purchases and other one-time factors. They may be right, too. Stock market investors certainly share their optimism: the Standard Poor’s 500 index is near a postrecession high.

But both Wall Street and Washington were also optimistic around this time last year — too optimistic. The unfortunate truth is that the recoveries from financial crises have a habit of disappointing.

Crises do so much damage that they leave businesses and households predisposed to believe the worst and to pull back at the first hint of economic weakness. Households are slow to resume spending. Banks are slow to lend, especially to small businesses. Companies are slow to hire.

All this is why the typical financial crisis has caused unemployment to rise for almost five years, according to historical work by the economists Carmen Reinhart and Kenneth Rogoff. We are well ahead of that timetable, thanks to aggressive action by the Fed, the Obama administration and, in its final months, the Bush administration. But our working assumption should be that this recovery will remain at risk for a long time.

If it stalls out for a second year in a row, the consequences could be particularly bad. The specter of a “lost decade,” like Japan’s, would become commonplace. Pessimism would feed yet more hesitation from businesses and households. For Mr. Obama himself, of course, the raid in Abbottabad could become a version of President George H. W. Bush’s Gulf War: the foreign policy triumph that turned into an electoral footnote.

I suspect that Mr. Obama’s advisers have remained publicly optimistic over the last few months because they consider optimism to be one of the few economic tools they have left. The sensible step for Congress would be to pair long-term deficit reduction with a mix of short-term tax cuts and aid to states, whose budget cuts are leading to layoffs. But Congress hasn’t shown itself capable of separating the short term and long term. So the odds of new legislation to help the economy anytime soon are roughly nil.

Even so, there are still two steps the White House can take, and now is the time to start planning them. If policy makers wait to take action until the recovery has undeniably stalled — as they did last year — they will have waited too long.

The first step is to remember the economy’s vulnerability when negotiating a deal over the debt ceiling. Congress and the administration have until August to increase the federal government’s authority to borrow money, and Republican leaders say they will insist on spending cuts as part of any agreement.

There are still plenty of sensible cuts for the two parties to make. Tax breaks (which many economists consider a form of spending) for both businesses and individuals can be reduced. Military spending, which has risen more than 70 percent in inflation-adjusted terms over the past decade, can be cut, too. Many social programs, meanwhile, don’t focus enough on outcomes and waste money in the process.

But it would be folly to start making these cuts immediately and potentially put people out of work. Last month’s deal to avert a government shutdown did a good job of minimizing the number of cuts that would affect the economy this year. Policy makers would be wise to repeat the pattern in the debt ceiling talks, making more future cuts and fewer immediate ones.

The second step involves the only way in which I can imagine Congress taking action to help the economy.

At the end of this year, about $225 billion of temporary tax cuts and emergency jobless benefits are scheduled to expire. These provisions were part of the compromise bill in last year’s lame-duck Congressional session that also extended the Bush tax cuts. The Bush tax cuts were extended through 2012, however, while the other provisions — including a payroll tax cut for households and a tax cut for expanding businesses — expire at the end of 2011.

Given the legitimate concern about the deficit, many members of Congress will want to let these temporary tax cuts lapse. But if the economy remains weak, continuing them for one more year will make sense.

Their economic impact is not small. Moody’s Analytics estimated that the economy would have 1.1 million more jobs at the end of 2012 if the tax cuts and jobless benefits were extended. Yet their impact on the long-term debt is minimal. Tiny changes in Medicare could more than pay a one-time, $225 billion bill.

Somewhere — in the White House or in the halls of Congress — somebody should be coming up with a plan to sell an extension of these measures. Persuading a financially battered public that it deserves another short-term tax cut isn’t likely to be too difficult.

Above all, Washington should avoid the temptation to get giddy about any one piece of economic good news. Those bits of encouraging news will happen. We may even get one on Friday, when the Labor Department reports on job growth in April.

The big lesson of financial crises is that too much optimism exacts a steep cost. You can make a case that the long hunt for Osama bin Laden offers the same lesson. A tough job is not done until it is undeniably done.

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