How Congress Can Derail the Improving Economy
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The Fiscal Times
December 5, 2011
  • Many economists now expect fourth-quarter growth of about 3 percent
  • Fiscal drag could cut up to 2.6 percentage points from first-half GDP growth
  • Household savings has fallen to 3.5 percent of income, a four-year low

Washington’s ideological battle over how to restore fiscal stability continues to go nowhere—and the chief casualty is the U.S. economy. The Congressional Super Committee’s failure to agree on a plan for short-term stimulus and long-term deficit reduction means that policy uncertainty still reigns among boardrooms and households. Plus, without new action by the end of the year, several expiring programs will cut sharply into household incomes and spending early next year. The sad fact is that Washington’s gridlock threatens to curb economic growth just when the economy is starting to show some momentum.

A bevy of economic data make it clear that the economy is pulling out of its slump in the first-half, when real GDP growth fell to an average annual rate of only 0.9 percent. The economy grew 2 percent in the third quarter, and the breakdown of GDP flashed positive signs for fourth-quarter growth. Spending throughout the economy last quarter was the strongest since late-2010, and businesses saw their inventories dwindle by so much that stockpiles will have to be built up again in coming quarters. Many economists now expect fourth-quarter GDP growth of around 3 percent—a pace consistent with faster job growth.

The latest data support that expectation, especially news from the labor markets. Payrolls posted a broad rise of 120,000 in November, with a larger 140,000 gain in the private sector, even as the unemployment rate dipped to 8.6 percent, from 9 percent in October. Job gains over the past three months have averaged 143,000, up from only 83,000 in the previous three months. On the heels of strong retail sales in October, November ushered in a bounce in consumer confidence, a booming start to holiday shopping, and the best showing for car sales since the cash-for-clunkers surge in 2009. Plus, the nation’s purchasing managers last month reported a continued rebound industrial activity.

Will the momentum continue? Much will depend on Washington. The problem heading into 2012 is the fiscal drag on economic growth from expiring stimulus programs, including the last vestiges of the 2009 Recovery Act and this year’s temporary stimulus from the cut in payroll taxes and extension of unemployment benefits. Economists at J.P. Morgan estimate that, if all these programs expire on Dec. 31, as scheduled, the total fiscal drag on real GDP growth in the first half of 2012 would add up to 2.6 percentage points on the average annualized growth rate of GDP, with the biggest hit in the first quarter.

The focal point right now is the payroll tax cut and extended jobless benefits. Economists have already factored into their forecasts the loss of stimulus from the Recovery Act provisions, but the additional loss of these two programs would be a big blow to consumers, whose spending makes up 70 percent of GDP. “The end of these stimulus measures would pose a noticeable headwind to disposable personal income growth early next year,” says Barclays Capital economist Troy Davig. Less income would mean less spending, following by second-round effects on production and hiring.

James C. Cooper
was BusinessWeek's senior editor, senior economist and author of its influential Business Outlook column. Prior to that, he was an economist at the American Paper Institute, performing economic analysis and forecasting. He holds bachelors and masters degrees in economics.