Tags: inaction | fiscal | cliff | economy

Inaction on 'Fiscal Cliff' Starting to Weigh on Economy

Sunday, 08 July 2012 06:10 PM

Congressional unwillingness to deal with an upcoming one-two punch of tax hikes and spending cuts is starting to hamper an already cooling economic recovery, experts say.

At the end of the year, tax breaks such as the Bush-era tax cuts expire, while automatic spending cuts agreed to during the 2011 debt-ceiling deal kick in. The combination of the two on Jan. 1, 2013, known as a fiscal cliff, could siphon as much as $500 billion out of the economy next year alone, according to some estimates, and wipe out a total of $7 trillion over a decade.

Congress could step in and adjust the scope or timing of the tax breaks and spending cuts, but lawmakers appear unwilling to address the subject in an election year, leaving many to hope that a new government will return in early 2013 and deal with the problem retroactively.

But in the meantime, worries about fiscal inaction are starting to show up in lackluster corporate hiring as well as tepid consumer demand and spending figures, experts say.

“The biggest fear at the moment is that Europe will unravel, but concern that policymakers may let the nation go over the fiscal cliff is mounting,” says Mark Zandi, chief economist of Moody's Analytics, according to CNNMoney.

“The job market isn’t going to kick into high gear until Europe’s problems and our fiscal issues are [better] nailed down.”

Editor's Note: I Wish I Were Wrong — Economist Laments Being Right. See Interview.

The economy in June added a net 80,000 nonfarm jobs, less than expected by most economists.

Fears about the fiscal cliff alone may or may not have played a factor in the June numbers — nobody can predict the effects over one month’s jobs numbers.

But expect to see a trend develop as the rest of the year unfolds, experts say.

“Firms are being very careful about adding new full-time employees,” Nigel Gault, chief U.S. economist of IHS Global Insight, writes in a research note, CNNMoney adds.

“Uncertainties over the strength of global growth, the eurozone crisis, the fiscal cliff and the November elections are giving plenty of reasons for caution.”

Since the downturn, the Federal Reserve has stepped up to the plate to stimulate the economy via monetary policy tools.

On top of slashing benchmark lending rates to near zero, the Fed has acquired $2.3 trillion in mortgage-backed securities and Treasury instruments from financial institutions, injecting them with liquidity with the aim of pushing down long-term interest rates and encouraging investing and hiring.

Officially, such a policy is known as quantitative easing (QE), and the Fed has used the tool twice to stimulate the economy.

The Fed has also sold short-term Treasury securities in the open market and stocked up on longer-term Treasurys to accompany quantitative easing, a tool known as Operation Twist, which rolled out in 2011 and expanded to the end of this year.

Editor's Note: I Wish I Were Wrong — Economist Laments Being Right. See Interview.

Talk that the Fed will step in with a third round of easing is growing, especially in wake of weak jobs numbers this spring.

“Our forecast is for $500 billion for QE3 in September concentrated in the mortgage market. This is on top of Operation Twist,” says Priya Misra, head of U.S. rates strategy at Bank of America Merrill Lynch at a recent press conference.

The Fed has already rolled out two rounds of quantitative easing since the downturn, known widely as QE1 and QE2, snapping up $1.7 trillion in Treasury instruments held by banks and another $600 billion in mortgage.
This time around, QE3 will serve as a floor to keep the country's economy from stalling as opposed to spurring any time of recovery.

“Unfortunately, as the Fed has admitted, every additional round of QE has diminishing returns, especially in terms of feeding into the overall economy. We don’t think it will play a very big role the job numbers or GDP,” says Michelle Meyer, senior U.S. economist at Bank of American Merrill Lynch.

“We think if they were not to do QE, the economy would look weaker,” Meyer adds.

“The challenge that the Fed has is when the economy slows sufficiently, when the stock market sells off, when the inflation break-even falls, if the Fed does not come forward with the accommodation that they expect, then you see a further weakening in the economy. So the fact that we think that the Fed will satisfy basically what the market expects, and what the economy needs, we won't see a significant change to unemployment.”

Other experts agree that the diminishing effectiveness of monetary policy coupled with congressional divide over tax and spending policies in an election year mean the economy nowmay be as good as it’s going to get for a while.

“This economy has no forward momentum and little help from monetary or fiscal policy,” says Kathy Bostjancic, director of macroeconomic analysis for the Conference Board, the New York Times reports.

“As if that were not enough, ill winds are blowing in from both a contracting Europe and slowing growth in emerging markets.”

The nonpartisan Congressional Budget Office has said the fiscal cliff could send the economy double-dipping back into recession next year, and many economists worry that will be the case, especially as businesses hold up on investing and hiring.

“The risk-taking animal spirits have yet to return,” CRT Capital Senior Treasury Strategist Ian Lyngen tells CNBC.

Past fiscal stimulus measures rolled out early in the Obama administration coupled with residual effects from quantitative easing measures are keeping the economy on life support, for now.

“The U.S. economy has been unable to achieve escape velocity but the amount of monetary and fiscal stimulus in the system has proven adequate enough to keep it going at a 1-2 percent GDP pace. That is slow by historic recovery standards…it feels like a ‘zomb’-economy,” says Lyngen.
“People are increasingly worried about a double dip.”

Weak jobs numbers, economic uncertainty and growing unease about the fiscal cliff don't bode well for President Barack Obama, who won't be able to keep arguing that he inherited a deeply flawed economy from the Bush administration and that it's taking longer than expected to improve it.

The economy needs to add an average of 125,000 jobs a month just to break even and absorb those entering the work force, such as new college grads, says Robert Reich, who served as Secretary of Labor under President Bill Clinton.

The country added an average of 75,000 new jobs in April, May and June, down sharply from the 226,000 average for January, February and March, which likely reflected warm winter weather that brought construction jobs online early.

“Obama reiterated that he had inherited the worst economy since the Great Depression,” Reich writes in his blog. “That’s true. But the excuse is wearing thin. It’s his economy now, and most voters don’t care what he inherited.”

Obama, meanwhile, is relying on election-year advantages that come with being an incumbent, last week signing into law a transportation-spending package and an extension of low federal student loan interest rates.

Obama said in his weekly radio and Internet address Saturday that the measure will keep thousands of construction workers on the job and help students and their families, according to the Associated Press. But he said Congress should do more to promote infrastructure and reform and expand financial aid offered to students.

In the Republican address, Rep. Ann Marie Buerkle of New York said Obama's policies are “making things worse, starting with his health care law,” the AP reports.

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