End of Stimulus Could Pull Economy Down Further
Policy + Politics

End of Stimulus Could Pull Economy Down Further

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Can the economy thrive without government stimulation?

We’ll soon find out. Over 70 percent of stimulus package enacted in February 2009 is now spent, with most of the rest slated to go out the door before the end of the year for infrastructure projects. At the end of June, the Federal Reserve Board will shut down its bond-buying, monetary easing policy. And at year’s end, workers’ two percent payroll-tax reduction, several business tax breaks and the unemployment insurance extension that passed last December will expire.

With both parties  promising  to adopt policies to bring down the national debt – the only debate being how far, how fast, and how the government and the private sector will create jobs. But Is business ready to grab the ball and run?

The latest data isn’t comforting. Initial jobless claims ticked up during the third week in May to 424,000. And while that is still slightly below the average of the last four weeks, the direction isn’t good. Renewed weakness in the housing market in states like Florida, Georgia and New Mexico more than offset small declines in initial jobless claims in states like California and Michigan, where the technology and automobile sectors are showing renewed signs of life.

Economists are already tinkering with their forecasts. Heading into this year, optimistic forecasters were predicting 4 percent growth or better. But after the pace of economic recovery slowed to 1.8 percent in the first quarter, the new consensus shows 2011 growth at no better than 2.5 percent, which is not enough to bring down the unemployment rate. May unemployment numbers are due from the Labor Deptartment on Friday.  Joblessness remains stuck around 8 to 9 percent in most parts of the country. 

“We still see a pickup in the second half,” said Diane Swonk, chief economist for Mesirow Financial in Chicago, “but it’s nothing to write home about.”

The extent to which the economy was dependent on government stimulation was brought home last week by a new report from the non-partisan Congressional Budget Office. Its analysis of the effects of the February 2009 stimulus package showed that without that $830 billion in spending (about $43 billion more than initially expected), economic growth would have been 1.1 to 3.1 percentage points slower; the unemployment rate would have been 0.6 to 1.8 percentage points higher; and there would have been somewhere between 1.6 and 4.6 million fewer jobs in the economy. A third of the funds went to state governments, which enabled them to postpone the layoffs that are now going on across the country.

Despite those findings, Republicans remain dead set against the government spending more money on state aid or further stimulation even if the economy falters in the months ahead. “The Democrats’ 2009 trillion dollar ‘stimulus’ plan burdened our nation with record debt and deficits and failed to create jobs,” said a spokesman for Rep. Eric Cantor, R-Va., the House majority leader. “Of course, it is common sense that any infusion of that amount of money will have some economic effect, but the point is that the measure failed to create the jobs promised or live up to the administration’s own standard for success.”

The Republicans last week renewed their call for corporate tax reductions as the best way to stimulate the economy. But with most companies’ balance sheets flush with cash earning very low interest rates and with corporate debt levels substantially below where they were just before the recession, there’s little evidence to suggest that the lack of investment is due to a punitive tax environment. It would appear to have much more to do with a lack of opportunities.

And for that, international events can share at least some of the blame. Rising oil prices have served as a massive tax on the economy. And while gas-at-the-pump appears to have stabilized, the price shows no signs of falling. Saudia Arabia and Kuwait recently enacted huge payouts for their local populations to avoid the kind of “Arab spring” demonstrations that have rocked other Middle Eastern nations.

“They’ve got to keep prices up,” said Swonk.” Throughout the Middle East they’ve raised the ante as to what clearing price they need to balance their budgets.”

So with fiscal and monetary stimulation off the table, and oil prices stuck on high, what options are left? “It’s not a null set, but it’s close to nothing,” said Jared Bernstein, the former top economic aide to Vice President Joe Biden who recently joined the Center for Budget and Policy Priorities.

His suggestions for next year: keep the two percent payroll tax holiday in place for another year, and do a better job promoting exports. “We should urge Asian economics to discriminate less against our exports through their currency policies,” he said.

Related Links: 
What Recovery? Hopes for Economic Rebound Fade (CNBC.com)
Consumers Hold Back U.S. Growth, Rebound Seen Muted (Economic Times)
U.S.  Jobless Claims Unexpectedly Weaken (Bloomberg)