Economic Momentum

The economy has been sending more mixed signals of late: consumer spending is down again, the housing sector remains weak and the Fed has now lowered its growth forecast. Karen Dynan discusses the recent loss of economic momentum, what it means, and where we go from here.

TRANSCRIPT

Another Stimulus Counter-productive
I think, given our long-run fiscal problems, it would be very hard to justify another large fiscal stimulus package on the order of what we did last year. The package could actually be counterproductive if it increases peoples’ fears about the long-run fiscal problems. One reason that businesses are holding back right now on creating jobs is that there is so much uncertainty out there. Part of that is uncertainty about the economy, but part of that is uncertainty about policy. They don’t know when it is that the government will be able to address these long run problems, and they don’t know how the government will address these problems that are holding back job growth.

So I think it would be very hard to justify another large stimulus package, but on the other hand I think there are smaller things that the government could do (and should do) that can stimulate the economy. For example, I think the government should reinstate emergency unemployment insurance benefits. This would be channeling money to people who are, essentially, living hand to mouth. They would be likely to spend it, and they would be likely to spend it fast. You would be, essentially, channeling money towards the broader economy which would support the recovery and provide insurance against a double-dip.

Double Dip

Many people were expecting that private demand would be able to pick up to fill that entire gap, such that growth stayed constant or even picked up from the first half to the second half of the year. Now it just doesn’t look like that is going to happen. It looks like we’re going to see slower growth in the second half of the year than we did in the first half of the year.

A lot of people are now talking about a double dip. That is not the most likely outcome, but the recovery is not on solid footing right now, and there are some important risks out there right now. The housing market remains very fragile. There are still problems there that need to be worked out. We can’t count on the fact that house prices are now stable, and we may see another decline in house prices. The other big threat to the economy is that we may see further fallout in the U.S. financial markets from the sovereign debt and financial crisis in Europe.

Stimulus Has Peaked
The economy has lost momentum since earlier this year. Consumer spending, for example, was very strong early in the year. The last few months (including what we saw in today’s report) indicates that consumer spending has been more sluggish than it was before. This is similar to housing. Housing demand has looked weaker than it was earlier in the year.

I think the main force behind this is that there were temporary factors that were supporting economic growth in the first half of this year. Part of it was that firms were rebuilding inventories. They had drawn down their stocks during recession and they were building them back up to normal levels. That gave a nice boost to the manufacturing sector, but it’s a temporary boost. More importantly, the effects of last year’s very large fiscal stimulus package peaked in the first half of this year.