MARCH 31, 2011.
Handicapping the Economic Recovery
Japan, Europe, oil and the deficit all pose problems. But chances are growth will continue.
By ALAN S. BLINDER
If you're searching for a metaphor for the U.S. economy right now, think of an athlete who is recovering from serious injuries and must navigate a difficult obstacle course. She's getting into better shape but there are hazards along the way that might keep her from reaching the finish line.
Here's my list of the four biggest obstacles to recovery right now—in ascending order of seriousness:
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• The Japanese disaster: Many people view the physical and human tragedy now afflicting Japan as a serious threat to global recovery. Based on what's known so far, I don't. The horrors unleashed by the earthquake, tsunami and nuclear disaster are very real—and monumental in scale and scope. The human cost is incalculable. And the disaster is already causing some economic disruptions (e.g., to production in Japan and to global supply chains). There will be more.
But history teaches us that in well-ordered economies, such events generally prove to be no more than short-term setbacks. And this is Japan we're talking about. Its economy will likely bounce back relatively quickly.
• The European sovereign debt crisis: This one is starting to look like a hardy perennial. For about a year, the on-again-off-again fear has been that defaults or restructurings by Greece, Ireland, Portugal and others might impose huge losses on European banks, which are not too healthy anyway, thereby opening a new and scary chapter in the world financial crisis.
No one knows what the future might bring, but my guess is that history will prove to be prologue. The nations of the European Union have bickered, dithered and delayed time again. But each time, when push came to shove, they got their act together. We'll likely see more bickering and dithering. But a financial implosion in Europe seems unlikely. The stakes are too high, and disaster is too preventable. (Did someone say that in the summer of 1914?)
• The U.S. budget deficit: The unedifying and sometimes irrational political wrangling over our own budget deficit is more worrisome. There are three distinct hazards here.
First, the current budget battle might lead to excessively large cuts in federal spending at a time when the economy is still fragile—much like what is happening in the U.K. Frankly, I don't lose any sleep over this one. Gridlock will protect us.
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Second, failure to agree on a budget for fiscal year 2011—which is already six months old!—could lead to a shutdown of the federal government, as happened in 1995. Again, I'm not too worried about this because any shutdown would be brief, making it a big political event but a small economic one. Besides, the Republican leadership remembers 1995, even if many of the party's freshmen do not.
The third hazard, though unlikely, is scarier: Suppose we crash headlong into the national debt ceiling. President Barack Obama and Treasury Secretary Tim Geithner have stated that the debt ceiling must be raised, period. They have both arithmetic and logic on their side. After all, as long as the government runs any budget deficit at all, no matter how small, the national debt rises. But some politicians are impervious to reason. And some Republicans see the debt limit as a weapon to force budgetary changes they seek. It's a dangerous game of political chicken.
Games of chicken almost always end with one side or the other (or both) backing off. This one probably will, too. But now and then a game of chicken ends in a crash. What happens if this one does? Some people have raised the specter of default on the national debt. That seems most unlikely, but even talk of default could shake the financial markets. We need to avoid that.
Two other ill effects are more plausible. First, investors around the world might start thinking the U.S. has lost its grip, which would not do the dollar or our stock and bond markets any good. Second, since the federal government is now taking in only 57 cents for every dollar that it spends, hitting the debt limit could force an abrupt 43% cut in government spending. That might delight tea partiers, but it would be a serious blow to the American economy.
• The oil market: This is the most worrying. When we think about the many conflicts now going on in the Middle East, we think of hopes for democracy, concerns about radical Islamists, our military involvement in Libya and more. But economically, we think only about the supply of oil.
So far, the price of oil is up only about $20 a barrel—roughly to $105 from $85 on light crude. But if oil were to shoot up into the $150 range, as it did briefly in the summer of 2008, the world would face a major oil "shock." (It now faces a minor one.) Oil shocks tend to both raise inflation and slow down economic growth.
But there's a ray of sunshine even here. Recent research suggests that oil shocks are now less devastating than they once were. Some of the reasons are obvious (for example, we use much less oil, relative to GDP, than we did in the 1970s). Others are speculative (it seems we now adjust to shocks better.) But whatever the reasons, oil shocks since the mid-1980s have had far smaller effects on the U.S. economy than earlier ones did. Even prices of $150 per barrel would not hurt as much as they did in the 1970s and early 1980s.
So let's handicap the race. Imagine that each of the first three obstacles has only a 5% chance of derailing the recovery, the last one has a 25% chance, and the four events are independent. That adds up to 40%, leaving the betting odds in favor of our limping-but-determined runner. Still, 60-40 bets leave me uneasy.
Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve.
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