By Neil Irwin
Washington Post Staff Writer
Wednesday, October 28, 2009
Over the past year, the U.S. government has thrown almost every tool at its disposal toward making the economy grow again. And it has worked, at least for now.
The trillion-dollar question for the economy now is: What will happen when those government supports are gone? While the government has successfully jump-started the U.S. economy, there are emerging signs that its engine still isn't running very well, and may even sputter out.
The government has deployed about half of $787 billion in spending and tax cuts that were part of its stimulus package. It has executed the "Cash for Clunkers" program that boosted auto sales over the summer, and it has taken a wide range of steps to support the housing market. The Federal Reserve, besides cutting its target interest rate to nearly zero, has committed $1.75 trillion to unconventional programs meant to reduce interest rates.
The combined results of all those efforts will be on display Thursday, when the Commerce Department reports on gross domestic product for the July through September quarter. Economists expect that broadest measure of economic activity to have risen at a 3 percent annual rate, compared with a 6.4 percent drop in the first quarter, and forecasters expect growth to continue through year's end.
"The patient is out of intensive care, but is still highly medicated," said David Shulman, senior economist at the UCLA Anderson Forecast. "So you don't know how much of this growth is driven by short-term stimulus and how much of it is self-sustaining. My guess is this is going to be the best quarter of growth for a long time."
Besides the government programs, a major factor in the rebound is that companies have ramped up operations to restore inventories depleted during the recession -- although that boost to growth is also expected to wane in the quarters ahead.
The risk in the current crisis is that the structural changes occurring in the economy are so great that they will take far longer to play out than the government can maintain policies to support growth. Some remedies, such as the housing tax credit, may even serve to delay those structural adjustments.
The idea behind the government interventions was to boost economic activity when it otherwise would be far below its potential, supporting demand for goods and services of all types and helping instill confidence that the nation is not entering a downward economic spiral. Having bridged that down period, the economy should begin to improve on its own momentum as businesses ramp up production and begin hiring and making investments again.
That's the idea, anyway. But fundamental changes are occurring in the economy that could slow growth for some time. The United States needs to shift away from consumption and home building and toward business investment and exports. Meanwhile, whole industries from financial services to auto manufacturing to news media are being fundamentally remade.
Various elements of the government's efforts to prop up the economy will likely expire before those transitions are done. Cash for Clunkers is already over, having boosted auto sales during the summer but resulting in a 35 percent drop in the rate of sales from August to September.
"It may have pulled forward some sales that would have happened later, and led some people who to buy new cars who would have bought used," said Chris Hopson, an auto industry analyst at IHS Global Insight. "But in terms of lasting impact on the way the industry does business, we don't see there being much."
An $8,000 tax credit for first-time home buyers, which was part of the February stimulus package, is scheduled to expire Nov. 30, although Congress is moving to extend it into the spring. Other programs to support housing include help for people facing foreclosure and an expansion of Federal Housing Administration insured loans.
Economists at Goldman Sachs last week estimated that government supports for housing increased prices 5 percent over where they would be otherwise and that as the programs expire, "the risk of renewed home price declines remains significant."
The Fed has said its program to buy $300 billion in Treasury bonds will expire this month, and that its program to buy $1.45 trillion in mortgage-related securities will be wound down by the end of March 2010. (It has also indicated it will leave the bank lending rate it controls near zero for "an extended period," though there is plenty of disagreement among Fed watchers over just how long that period will turn out to be).
And spending through the $787 billion stimulus package known as the American Recovery and Reinvestment Act will taper off next year and into 2011. Nonprofit journalism group ProPublica estimates that there is about $291 billion left to spend, and $150 billion in tax cuts yet to play out.
"Programs like Cash for Clunkers and the home-buyer tax credit are like caffeine to the economy," in that the buzz dissipates quickly, said Ethan Harris, chief U.S. economist for Bank of America-Merrill Lynch. "The bigger program, the Fed monetary easing and the Obama stimulus plan, have a longer-lasting impact. But as we move out into the middle of next year, you need to see signs that economic growth has become self-generating. That's where we'll have a second test of the recovery."
Historically, some nations that experienced financial crises have rebounded relatively quickly, said Carmen M. Reinhart, a University of Maryland economist. But they tend to be nations that have moved more aggressively than the United States to remove bad loans from bank balance sheets, she said.
"We have stopped the freefall, with household spending and residential activity stabilizing and the fiscal stimulus kicking in," she said, "so the numbers for the second half are going to look like a recovery."
But Reinhart, the author with Kenneth S. Rogoff of "This Time Is Different," a history of financial crises, worries about what lies ahead. As she put it: "The question is how robust and how durable it would be. You eventually need some sort of normalcy in the availability of credit, but we haven't established that, or anything close to that."