Uncertainty ahead of the midterms

By Karen Dynan, Ted Gayer and Darrell M. West
Sunday, October 31, 2010; 12:00 AM

Two days before voters go to the polls, uncertainty - both economic and political - remains the watchword. The strength of the recovery is in question, as the economic growth spurt of late 2009 and early 2010 appears to have given way to a slog. In the sixth "How We're Doing" Index, a team of scholars at the Brookings Institution has looked at the past five quarters to assess data that underpin the national gloom. With midterm elections historically hard on the president's party when voters are worried about economic circumstances, the Republican Party may regain control of Congress - but on major issues of policy, uncertainty is likely to linger.

Third-quarter data show that economic growth remained tepid for the second consecutive quarter. Nearly one in 10 workers is unemployed, and the 17 percent underemployment rate - which includes marginally attached workers and people employed part time for economic reasons - remains near its record high from last October.

The housing sector, which has often led the way out of past downturns, continues to be troubled. A series of government interventions over the past several years has helped modestly turn around home prices after a 33 percent decline, but a glut of homes persists even after two years of historically low housing construction. Millions of people have lost their homes to foreclosure the past few years, and a further drop in house prices could put even more borrowers underwater and at risk of losing their homes.

Meanwhile, confidence has slid further: Consumer sentiment declined in the third quarter to its lowest level in more than a year. The National Federation of Independent Business's Index of Small Business Optimism was down. The National Association of Home Builders' measure of builder confidence was just a tad above its historic lows of early 2009.

What do these measures suggest? First, that consumers and businesses share the view of economic forecasters that the prospects for a rapid recovery are dim. A high degree of uncertainty surrounds our economic future and some issues of policy. Congress and the administration have not resolved whether, or to what degree, to allow the Bush tax cuts to expire as scheduled by year's end. The nation lacks long-term plans to address its deep debt. There has been little clarity on how or if the government will take on energy supply, climate change and immigration.

On issues of monetary policy, Federal Reserve leaders are talking about resuming their efforts to stimulate the economy by purchasing Treasury securities, but experts in and outside government continue to debate the size of the benefits and how to weigh them against the potential risks of inflation.

Political and governing concerns are driving uncertainty yet higher. Less than a third of voters felt the economic stimulus money hit the mark, an October Washington Post poll found, and 68 percent believed federal dollars were wasted. A Newsweek poll this month on the psychology of voter anger found that 68 percent are dissatisfied with the way things are going in the United States; economic conditions, not enough good-paying jobs, and low moral and ethical standards in particular provoked anger. Neither party generates much confidence in its ability to address problems such as health care, energy or housing.

Although Republicans are poised to pick up a large number of congressional seats, gridlock is the safest prediction for the post-election Congress. Whichever party ends up controlling the House and the Senate will have narrow majorities, making governing a challenge. Other aspects of our highly polarized political environment strain chances for solid bargaining and negotiation.

The public's lack of confidence bears importantly on how the future unfolds. If people feel uncertain about the economy and political leaders' abilities, consumers may hold back on spending and businesses may delay hiring and investment. This combination inhibits economic growth and perpetuates dismal economic conditions. The midterm campaigns and third-quarter data underscore the difficulty of generating a cycle of growth and confidence in the face of national doubts and anxiety.

Click here to see analysis of the data and video.

Karen Dynan and Ted Gayer are co-directors of the Brookings Institution's economic studies program; Darrell West is vice president of Brookings's governance studies program.

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