As economy lags, what levers to pull?

Pressure is mounting for the US government to act soon to prevent a recession.

SOURCE: Bureau of Labor Statistics /Rich Clabaugh–STAFF

Economic troubles are spreading beyond the US housing market, putting pressure on President Bush and other policymakers to try to prevent a recession.

What they do – or don't do – could have far-reaching implications: from the performance of the economy itself to GOP election prospects to Mr. Bush's own economic legacy. But any such efforts face two large hurdles. First, it is hard for policy to exert a rapid influence on the overall economy. Second, the president has less room to maneuver than in 2001, when he faced a similar slowdown. Then, federal budget surpluses allowed him to push through a tax cut with relative ease; now, he would need to convince a Democratic Congress either to expand the deficit or agree on how to offset the costs in the future. Still, the latest evidence suggests that the federal government must consider doing something.

Unemployment jumped to 5 percent of the labor force in a report released Friday. That's up from 4.7 percent the month before. In a disturbing parallel shift, private-sector job creation turned negative for the month. If that weakness persists and worsens, it would echo what happened the last time the US entered a recession, in 2001.

The slack job market creates an atmosphere of urgency for the president.

"The reports put the administration in rather a bad position," says J.D. Foster, a senior fellow at the conservative Heritage Foundation in Washington. "They don't want to fall into the trap" of appearing complacent.

Yet by considering action, the Bush team could raise public hopes for more than Washington may be able to deliver.

One key policy lever today is monetary. For several months, the Federal Reserve has been cutting short-term interest rates, and now more such cuts are expected. But economists say that it often takes six months or more for such moves by the Fed to have an impact.

Another lever – the one controlled by Congress and the president – involves "fiscal stimulus," such as tax cuts or government spending. Here, economists say the effects can sometimes be quick. But the process of legislation and implementation often takes considerable time.

With this being an election year, and with opposing parties dominating the two ends of Pennsylvania Avenue, the hurdles are even higher than is often the case.

Washington also has a third option beyond broad-based monetary or fiscal policy: Focused efforts to ease the real estate downturn that lies at the core of the economy's slide. Here again, however, politicians are divided about what to do.

A risk in rushing to enact policies is that they may come too late to be useful, may be counterproductive, or may not be needed at all.

"One shouldn't overreact to today's numbers. They are one-month numbers and they may get revised," says Alice Rivlin, a Brookings Institution scholar who served as President Clinton's budget director and then as a Fed official during the 1990s. Still, she says the signs of a slowdown in job creation "make it more likely that we are headed into a very slow growth period or maybe even recession."

Even a period of slow growth could be tough for America. Forecasters sometimes use the term "growth recession," referring to periods when the pace of growth fails to keep up with the size of the labor force.

Such a period may have arrived.

In the Labor Department's new report, the agency's survey of employers found that the economy generated just 18,000 jobs in December. And for the private sector (leaving out government jobs), the job-creation tally was negative: Some 13,000 jobs were lost last month.

After a meeting with policy advisers Friday, Bush called the economy "solid," but said "there are signs that cause us to be ever more diligent in making sure good policies come out of Washington."

The job numbers are just one of the signs. High oil prices, tighter lending standards by banks, and declining home prices are additional forces that weigh on consumers. That, in turn, dampens the desire of businesses to expand operations.

Part of the pressure on Bush is political. Historically, a bad economy in an election year tends to hurt the party that controls the White House.

Beyond that, policymakers of all stripes have an interest in keeping the economy as strong as possible. The question, as always, is how to do it.

Talk of fiscal stimulus has grown louder in recent days.

One reason is that so far, policy efforts to contain the housing slump have had only limited success.

Similarly, the Fed can only do so much.

At a time when banks are wary of lending and businesses are wary of investing, interest-rate cuts may be relatively ineffective. Moreover, if monetary policy gets too easy, inflation could pick up – creating a new problem rather than solving one.

Still, Wall Street traders now expect the Fed to cut rates again this month, perhaps by as much as half a percentage point. Investors signaled their worry about the job market Friday by pushing the Dow Jones Industrial Average below 13000.

Prominent economists on both left and right – including conservative Martin Feldstein and former Clinton official Lawrence Summers – now say the risk of recession warrants some fiscal stimulus.

"There are a variety of options we can consider," White House economic adviser Edward Lazear said on CNBC Friday.

Bush is expected to comment further on the economy in a speech Monday. A proposal could take shape for Bush's State of the Union address in a few weeks.

What can a fiscal stimulus plan accomplish?

The general view of policy experts is perhaps something, but probably not a lot. The political backdrop is difficult, and so is the budgetary one.

Bush has already won large tax cuts. Meanwhile, in coming years the federal government faces a looming difficulty paying for all the spending commitments. That leaves politicians a bit less room to bring taxes down lower for short-term needs.

"What the Bush administration did [in 2001] was accelerate the tax cut by sending out the so-called rebate" checks, Ms. Rivlin says. "That had some effect."

Given the long-run fiscal challenges, she says Congress might insist that any fiscal stimulus be paid for at some point, and not simply add to government debt. "The Democrats have, rightly I think, put a lot of emphasis on fiscal responsibility and things being paid for."

Mr. Foster says one possible tax cut might be to make property taxes deductible from the federal income tax even for people who don't itemize their deductions. This would put money in many pockets. And assuming it was a permanent change, this move would bolster home values – a boon since foreclosure often occurs when a property's value falls below the borrower's loan balance.

Chad Stone, chief economist at the left-leaning Center on Budget and Policy Priorities, says any stimulus package should be carefully targeted to bolster consumer spending and help households most in need. Extending unemployment insurance and expanding food-stamp aid are two examples, he says.

Or, since states face pressure to curb spending during recessions due to budgetary constraints, Congress could provide aid to state and local governments. This might allow them to avoid cuts in Medicaid.

Another idea, floated by Harvard University's Mr. Feldstein, is a uniform rebate for each US taxpayer.

A key priority is timing. Both Feldstein and Mr. Stone support a policy with triggers, so that it goes into effect only if several months of data confirmed deep problems for the economy. Passing such a bill soon would ensure that help comes quickly if it is needed.

"There's a high risk of bad policy" or, more likely, no policy, Stone says. "We have to hope that the [consensus] forecast is correct – that we don't even go into a recession."

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