Tags: economy | exit | strategy

U.S. Economy Not Ready for Exit Strategy

Tuesday, 13 Oct 2009 03:10 PM

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ST. LOUIS -- U.S. officials must figure out what to do about an economy that is growing yet not generating enough jobs before they can shift their focus to dismantling their multi-trillion-dollar rescue programs.

Two deadlines are looming.

The first is the $12.1 trillion federal debt limit, which will soon be reached unless Congress agrees to lift it.

The second is the 2010 election season, when most members of Congress will be out on the campaign trail. If unemployment is still near 10 percent, as many forecasters predict, that will not sit well with voters.

Unfortunately for the White House, Treasury and Federal Reserve, those two factors are somewhat in conflict. While creating jobs may be an economic and political imperative right now, it costs money, and there is a limit to what even the United States can borrow and spend.

That dilemma was clearly on the minds of officials speaking at an economics conference here this week. White House economic adviser Lawrence Summers said there was no higher priority than strengthening the economy so that it can generate more jobs.

How the government will go about doing that is unclear.

"The administration is always evaluating different options," said Alan Krueger, assistant Treasury secretary for economic policy, when asked what more could be done to spur job creation. "It would be irresponsible if it weren't. We're constantly looking to see what's been effective, what might be more effective."

The U.S. economy probably grew at around a 3.2 percent pace in the just-ended third quarter, according to a Blue Chip poll of economists. That would be faster than the longer-term trend, which means pouring in more public money could overstimulate it, weakening the value of U.S. dollar and driving up inflation.

Yet despite that above-trend growth, the economy shed more than 760,000 jobs in the third quarter, according to Labor Department data.

Even as the Obama administration seeks to ensure it is taking appropriate steps to lift the economy in the near-term, it may soon need to shift tack to how it will rein in the record U.S. budget gap.

In a nod to concerns about the large federal deficit, inflation and the value of the dollar, Summers cautioned against simply throwing piles of public money at the economic problems without considering the longer-term consequences.

"No actions to combat short-term output gaps must be taken that call into question our commitment to sound money and noninflationary growth," he said.

WHAT OPTIONS ARE LEFT?

In 2008, the Fed did the heavy lifting in trying to stimulate the economy, taking its benchmark interest rate down from 4.25 percent to near zero, where it remains now.

That essentially leaves its hands tied. If anything, the Fed may need to begin raising interest rates before the unemployment rate, which hit 9.8 percent last month, gets below 9 percent -- something it has never had to do since it began targeting the federal funds rate as its principle form of monetary policy in the early 1990s.

"Politically it may be difficult but economically it probably will be necessary" to hike before the job market is healthy, said Lynn Reaser, an economist and incoming president of the National Association for Business Economics.

That leaves fiscal policy, which is a tricky proposition when the federal debt is already close to bumping up against the $12.1 trillion ceiling.

As Summers' comment on "sound money" indicates, the White House is well aware that it must continually reassure investors at home and abroad that it has a firm grip on finances.

If the United States lost credibility on that front, borrowing costs would undoubtedly spike, making an already grim deficit outlook even darker.

Most analysts expect Congress will ultimately lift the debt limit, as Treasury has requested, but not without a fight.

"It is entirely plausible that the debt limit debate late this year will set the stage for a political campaign season in 2010 with (a) focus on tension between the ultimate need for fiscal tightening and what may still be a need for more fiscal stimulus in the short term," Goldman Sachs economist Alec Phillips said.

And until that fight is finished, the only additional step the government is likely to take is extending unemployment benefits. While that may cushion the blow of losing a job, it doesn't create new ones.

Some of the jobs that have been lost probably won't come back, particularly in sectors such as auto manufacturing and home construction. That means other areas will need to grow even faster to pick up the slack.

Citigroup economist Steven Wieting said the government would probably get the biggest bang for its buck by improving financing and hiring incentives for small businesses, which are having a tough time obtaining credit.

That ought to be a popular program with bipartisan support, but Congress' calendar is full at least through the end of the year with healthcare and regulatory reform.

That suggests 2010 will be a busy year for the White House and for lawmakers on Capitol Hill, and the much-discussed exit strategy from emergency economic aid programs will have to wait.

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