Policymakers on both sides of the Atlantic, facing sharp political divisions, are failing to take the ambitious steps that economists say are vital for stabilizing Europe’s economy and assuring healthy growth in the United States.
This weekend in Europe, after a long period of gamesmanship, Spain agreed to a $125 billion rescue of its banks by Germany and other nations, reducing fears that the continent’s fifth-largest economy could suffer a banking sector collapse. Yet this coming weekend, Greek voters might give power to a party that opposes taking part in the continent’s financial stability plan, potentially leading to more serious phase of crisis if Greece then is forced to exit Europe’s economic union.
In the United States, meanwhile, policymakers have not taken steps to boost a slowing economy that is feeling the effects of the European crisis. Nor have they agreed on what to do about a package of automatic tax hikes and deep spending cuts that could undermine the economy if they take effect as scheduled at year’s end. President Obama’s press conference Friday, aimed at encouraging European officials and American legislators to move faster in tackling economic threats, devolved into an exchange of barbs between the presidential campaigns.
It has been a recurrent theme for the past three years: Policymakers facing political constraints have taken only relatively modest actions to address financial and economic challenges as they surface – steps that later turn out to be inadequate.
“It is a cycle that has become too familiar since the start of the crisis, like a movie we have watched too many times,” Christine Lagarde, managing director of the International Monetary Fund, said Friday night. “With the passing of each cycle, we reach a higher and higher level of uncertainty, and the stakes rise.”
The depth of political division in the United States was on display this weekend. On Saturday, R. Glenn Hubbard, an economic adviser to GOP presidential candidate Mitt Romney, took to the pages of the German publication Handelsblatt to criticize Obama’s guidance to the Europeans. He argued that cutting spending and restoring the faith of investors in government bond markets are superior to more bailouts.
“In a hitherto unprecedented manner, the Obama administration is trying to force Germany to assume liability for financially weaker governments and banks, so that the Greek crisis doesn’t spread to other countries,” Hubbard wrote, according to a translation of the article. “These suggestions are not only unwise. They also reveal ignorance of the causes of the crisis and of a growth trajectory in the future.”
On Sunday, David Axelrod, a top Obama campaign adviser, attacked Romney for his opposition last week to more federal spending spending to keep teachers employed amid heavy layoffs by states and localities.
On CNN’s “Face the Nation,” Axelrod said that “250,000 teachers have lost their jobs in the last couple of years. That is dramatically bad news for the country. It’s certainly not good news for our future. What planet is he living on where he thinks that we can take these kind of hits in our education system and progress as a country?”
Unlike Europe, the United States is not facing a massive financial crisis or the potential of a deep recession. But for the third year in a row, the U.S. is confronting an economic slowdown and a lull in hiring.
When the nation faced a severe crisis four years ago, the Bush administration and the Federal Reserve unveiled a massive plan to save the financial sector. The Obama administration then passed a big stimulus to reverse the plunge in economic activity.
To be sure, leaders in both cases faced political constraints but were able to overcome them. For one, the problem was immediate and black and white. The U.S. banking system was near collapse and the economy was in a tailspin.
But more than that, policymakers had room to act. When the Bush administration moved to rescue the financial system, Bush was in his last months of office and didn’t need to worry about reelection. When Obama took action early on in his term, he had the luxury of a Congress controlled by his own party.
After the initial efforts failed to help as many Americans as hoped, political opposition to more federal spending to aid the economy mounted. Republicans, soon resurgent in Congress, wanted immediate action to bring down the soaring federal debt. And Obama, while continuing to make proposals to lift the economy, had other priorities, too, such as overhauling health care and Wall Street regulation.
As a result, the U.S. economy was less insulated from unexpected drags – whether it was the Europe crisis starting more than two years ago, the oil market shocks that occurred after the uprising in Libya last year or the unexpected slowdown in emerging market economies this year.
The behavior of policymakers themselves also took a toll on the economy.
“The brinksmanship last summer over the debt limit had very significant adverse effects for financial markets and for our economy,” Fed Chairman Ben S. Bernanke told Congress last week. “It really knocked down consumer confidence quite noticeably.”
Economists say that uncertainty about tax hikes and spending cuts that could kick in at year’s end is causing deep anxiety in markets. If they take effect, they could trim several percentage points from economic growth next year, economists say.
Many analysts say the right prescription for the U.S. economy is a gradual plan to reduce budget deficits through some mixture of tax increases and spending reductions – perhaps coupled with a short-term stimulus plan to further drive growth.
“Abrupt short-term measures could be self-defeating when domestic demand is weak,” analysts at Standard & Poor’s, the credit rating firm that downgraded the U.S. rating last year, said in a report Friday.
The Fed, meanwhile, has been cautious lately about launching major new programs to stimulate economic growth, though it has insisted that it would act if economic conditions worsened significantly.
The Fed holds its next policy-setting meeting next week, but central bank officials worry that acting prematurely might increase the risk of unsettling side effects like fast-rising inflation. They also are pressuring legislators to act themselves.
“Monetary policy is not a panacea. It would be much better to have a broad-based policy effort addressing a whole variety of issues,” Bernanke said last week. “I’d be much more comfortable if, in fact, Congress would take some of the burden from us.”
Europe, too, has been stuck in a routine of two-steps-forward, one-step-back – though with much more pressing dangers at hand. The continent is suffering a intertwined crisis of dwindling investor confidence in national debts, weak banks and inadequate economic growth.
For much of the past several years, in large part because of German reluctance to bail out less disciplined neighbors and the European Central Bank’s desire to impose tough financial reform programs on struggling countries, the focus has been on only one of these challenges: restoring investor confidence by cutting deficits.
That austerity-minded approach has taken a toll on economic growth and employment. It gave rise to political parties in Greece that are skeptical of continuing to take part in the bailouts and led Spain to be hesitant to accept any aid from Europe for its banks.
“The cycles are now threatening the very existence of the European project,” Lagarde said Friday. “The policy debate needs to move beyond the false dichotomies of growth versus austerity, stability versus opportunity, national versus international interests.”
Reflecting a consensus among economists, Lagarde said that European countries must continue to support economic growth across the region and that the ECB, in particular, should take more steps to keep interest rates low and keep financial markets stable.
Other economists have suggested broader steps, including shared banking oversight, deposit guarantees and responsibility for paying back national debts across the euro zone.
Some investors remain hopeful that things might yet turn out all right. Germany and other countries were willing to rescue the Spanish banking system on terms favorable to that government. Greece, though important to financial markets, represents just 2 percent of the euro’s gross domestic product.
Although they face severe challenges in the financial markets, the fundamentals of Spain and Italy, with vibrant manufacturing bases, are conducive to long-term economic growth.
“Leaders of the important countries are desperately seeking a solution to the current problems,” Byron Wien, vice chairman of the massive asset management firm Blackstone, wrote Friday. “They know they have more to lose than to gain if the European Union dissolves and they go back to their national currencies. “
Staff writers Anne Midgette and Howard Schneider contributed to this report.