TEETERING U.S. ECONOMY NEEDS STIMULUS FIRST / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Teetering US economy needs more stimulus first

Roger Altman

June 15, 2011

Finally, America is on the verge of a major step towards reducing its dangerous and long-term fiscal deficits. This was seen as impossible six months ago. But, a combination of growing public antipathy to deficits, and, in particular, fierce opposition to raising the federal debt limit this summer has changed the environment and put Congress into a bind. It must raise the debt ceiling to enable continued national borrowing and avoid a catastrophic default. So, for political protection, its members now want to deliver a simultaneous, large deficit reduction package. Negotiations focus on $1,000bn-$2,000bn of reduction over 10 years, against an August 2 deadline on the debt limit. It may occur at the midnight hour, but an agreement is likely.


It is important that Congressional and White House negotiators settle on sector-by-sector reductions. Just setting future targets will not be credible. The approach also should be broad-based, including reductions in both tax expenditures and entitlements. But, even a $1,000bn deal would represent a quarter of the amount ultimately needed to stabilise the debt/gross domestic product ratio and solve the problem entirely. Crucially, it would reassure everyone that America is moving to fix this problem which is so threatening. Such an agreement would be an unambiguous plus, with one, key caveat.


Namely, the already anemic economic recovery has recently slowed even further. The evidence is unmistakable, which is why share prices have fallen for six straight weeks. This new weakness carries three implications for the deficit negotiators: 1) they should still press ahead to reach agreement; 2) the effective date of their reductions should be 2013, not next year; and 3) the three stimulus measures adopted in December last year should be extended one more year.


How serious is this new economic softness? The very latest data are clear. Manufacturing growth has slowed, consumer confidence is retreating and home prices continue to fall. Most importantly, labour markets are losing the limited momentum they had achieved. Last month produced only 54,000 new jobs and a rise in the unemployment rate to 9.1 per cent. A rate that high two years into the recovery is profoundly disturbing.


Yes, there are temporary factors involved, like higher gasoline prices, supply chain impacts of the Japan tragedy and widespread flooding. But, it is unlikely that these explain all of the recent slowing. Indeed, most 2011 growth forecasts are now below 3 per cent.


This should not slow the deficit reduction negotiations. An agreement is necessary to avoid the projected, very high US debt ratios which could trigger another financial crisis. It also would boost business and investor confidence. That will eventually translate into higher portfolio and fixed investment and assist growth.


But this impending agreement should include two additional features which, until recently, would have been unnecessary. The first concerns the year in which deficit reduction kicks in. Remember that it is, in theory, contractionary. This suggests that the start date should be deferred. Instead of immediate reductions, an effective date of 2013 makes more sense, in the expectation of a stronger economy. Second, the three one-year stimulus measures passed in last winter’s special Congressional session should be extended one more year.


The first of these was a payroll tax cut for employees, temporarily reducing their rate from 6.2 per cent to 4.2 per cent. This is good policy, as President Barack Obama just said, because its benefits primarily flow to individuals with a high propensity to spend. The second permitted business to deduct 100 per cent of this year’s capital expenditures for tax purposes, as compared to the usual, longer depreciation periods. Business investment is one of the few strong spots now, suggesting that this provision helped. Finally, emergency unemployment insurance, which temporarily extended benefits to 99 weeks for some, was continued through 2011. With job growth still so weak, many recipients cannot consume without this stipend.

These should be extended one last time because this fragile economy needs the boost. In particular, the phasing out of the big 2009 stimulus now represents an economic drag equaling 2.5 per cent of GDP. That is too much but would be mitigated by this three-part, $200bn infusion. Ideally, the budget negotiators would support these extensions now and send that positive signal, even though the three measures don’t expire until year-end.


It is incongruous to fashion a 10-year deficit reduction package which adds stimulus at the beginning? No. This amounts to helping the economy regain enough momentum, especially on job creation, to then take deficit reduction in stride. After all, the cuts will be permanent and the stimulus would cover only 2012. It is good economics and would be good politics.


Roger C. Altman is founder and Chairman of Evercore Partners and was US Deputy Treasury Secretary in 1993-94.