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November 1, 2010 10:25 pm
After the worst economic downturn in 80 years, which continues to cause immense hardship, the prospects for the US economy are the most complex and uncertain in my adult lifetime, creating a difficult decision-making environment for policymakers and markets. There are realistic chances of a healthy recovery in the shorter term. However, we face enormous headwinds: high unemployment and low job growth; both a decline in fiscal demand and unsustainably high federal deficits; excess capacity; business uncertainty; weak consumer financial conditions; and much else.
So, the probabilities are much greater that growth will be slow and bumpy, and unemployment high, for an extended period. A double dip, however, seems relatively unlikely, because jobs and investment show some growth, and exports are strong.
I agree with the administration’s targeted budget additions that might be particularly powerful economic catalysts, such as small business support, or might meet other immediate imperatives, such as extending unemployment insurance and state aid for teachers. Hopefully, other targeted proposals will be developed with especially strong economic impact or hardship relief. More broadly, a major new stimulus could well be constructive, if it is tied to real, trusted and enacted long-term structural deficit reduction. Otherwise, a major new stimulus is likely on balance to be counterproductive, initially or over time. It could seriously increase business uncertainty about future economic conditions and policy, or change market psychology unexpectedly and dramatically, causing serious market disruptions. Or, even if a major new stimulus worked initially, it could fail to generate lasting momentum due to the headwinds, leaving us worse off than we would have been, with more debt but no greater gross domestic product.
Another macroeconomic tool, quantitative easing, has been used aggressively. The much-discussed extension could work. Alternatively the economic effect could be quite limited, since interest rates are already very low, the stock market impact and consequent effect on consumption are uncertain, deflationary expectations are not currently significant economically, and weakening the dollar could generate harmful reactions elsewhere. And a large, new round of quantitative easing has real risks: undermining confidence in the Fed’s ultimate refusal to monetise our debt; undesirably heightened inflationary expectations more broadly, now or later, or actual inflation; and competitive devaluations and trade restrictions.
Beyond macroeconomic policy, action in other areas could significantly enhance our prospects. The administration’s response to the financial crisis, last year’s stimulus, and this year’s financial reform have, on the whole, been sound and effective. Nonetheless, there is strain between business and the administration, which could be reduced by each better understanding the other’s perspectives and difficulties. Relatedly, the administration, business, and all other interested parties, should work together more effectively on regulatory issues, to promote strong protection while also taking into account the effects on economic activity. With close to $2,000bn of cash on non-financial corporate balance sheets, bolstering confidence and improving the business environment could significantly affect investing and hiring. Enacting trade agreements would also be constructive. But, more broadly, there are complex issues with respect to other countries’ non-market policies that affect trade. In addition, the trade area poses global risks of protectionism or competitive depreciation.
The administration and Congress should work over the next six months to enact the first phase of a serious fiscal plan, to take effect in two or three years, that must also include room for critical public investment. This first phase of deficit reduction should work towards a gradual decline in the debt/GDP ratio, not just stabilising it at a relatively high level that will inevitably ratchet up. The long-term objective, in a later phase, should be a balanced budget.
Even this “first phase” will be difficult. But it can buttress business confidence, reduce shorter-term market risks and start building the fiscal base for longer-term economic success. In that context, I think the 2001 and 2003 tax cuts on incomes over $250,000 should be allowed to expire, to avoid the appearance of the political system being unable to follow through on planned fiscal constraint even on what should be a relatively less difficult issue. The remaining tax cuts should be extended for two or three years, and reviewed in the “first phase” fiscal plan.
For the longer term, the US has a dynamic and entrepreneurial culture, flexible labour and capital markets, the rule of law, relatively favourable demographics and other great strengths. But, in a global economy undergoing historic transformation, we must meet hugely consequential challenges to realise our potential for competitiveness and growth, and to achieve widespread income gains rather than the lagging middle income wages experienced over most of the last 30 years.
Meeting our challenges means moving from our current risk-laden fiscal trajectory to a sound fiscal regime and public investment and reform in economically critical areas, such as education, healthcare costs, infrastructure, immigration and others. Effective government to undergird a market-based economic system is not a liberal idea, but a practical imperative to meet the needs for a successful economy that markets won’t fulfil.
Thus, our most fundamental challenge is the effectiveness of our political system. Despite substantial legislative actions over the past year and a half, there is widespread and serious concern about the willingness to work across party and ideological lines and to make the tough decisions, necessary to meet our challenges. The historic resilience of our political system, our economy, our culture and our society is a hopeful augur. We have risen to difficult challenges many times in the past and we can do so again. But there is much to do.
The writer is co-chairman of the Council on Foreign Relations and former US Treasury secretary
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