A Sickly Economy, With No Cure in Sight
By DAVID LEONHARDT
WASHINGTON — For much of the last month, the people responsible for the health of the sputtering economy have been performing a series of emergency procedures.
With the economy showing new signs of weakness, the House and Senate overcame sharp differences last week to pass a $320 billion tax cut intended in part to increase stock prices and give households additional money to spend. Alan Greenspan has been assuring investors that the Federal Reserve will act aggressively to prevent deflation, an unlikely but dangerous possibility.
And Treasury Secretary John W. Snow, by speaking without concern about the dollar's recent decline, has helped push it down further versus the euro, aiding American manufacturers by effectively cutting the price of their products relative to those of foreign rivals.
Few policy makers or economists question the need for action, even if some are unhappy with the particulars. After roughly three years of falling stocks and rising unemployment, another downturn could create a whole new class of problems. The already big pool of the long-term unemployed could swell. Inflation — now near its lowest level in decades — might turn into deflation, a sustained decline in prices that can set off a vicious cycle of wage cuts and unmanageable debt.
But even if tax cuts and carefully chosen words represent a sensible form of insurance, they seem unlikely to accomplish what everybody agrees is the ultimate goal: the creation of a truly healthy economy, one in which stocks, wages and company payrolls are rising, without an enormous financial bubble as a main cause.
On balance, in fact, the steps being taken to pull the economy back from the precipice may delay the arrival of one able to stand on its own. "What we're doing now is trying to create a cyclical pop with a massive policy response," said James W. Paulsen, one of the few forecasters to predict the 2001 downturn and the chief investment strategist at Wells Capital Management in Minneapolis. "That may well succeed — I think it will. But very little of it will solve the problems that got us into this situation."
Instead, those problems — consumers who remain financially stretched, a corporate sector that has not yet won back the trust of many investors and a government living well beyond its means — will weigh on the underlying strengths of the American economy.
Those strengths are not small, as continuing increases in productivity and the even slower growth of Europe and Japan have made clear.
"We have in place probably the best economic infrastructure" in the world, said Douglas J. Holtz-Eakin, the director of the Congressional Budget Office. "We actually get rid of nonperforming assets."
None of that is new, however, and the economy's problems have existed long enough to raise the questions of whether slow growth is the new reality, and whether good times like the boom of the late 1990's can exist without the help of a bubble.
In Washington, the problems start with a budget deficit that is expanding more quickly than it was even a week ago. Then there are ticking fiscal time bombs like the retirement of baby boomers (which will lower the government's income tax revenues, while threatening to bankrupt Social Security) and the alternative minimum tax, a once-obscure provision that is raising the taxes of a new set of households each year.
In future years, the upshot of these trends is likely to be a politically painful choice between higher taxes and lower government benefits.
Last week's stimulus bill added to the list of tough decisions to be made another day. To hold down the cost of the plan, Congress created tax cuts and tax credits — for married couples, parents and stockholders — that expire after a few years, leaving tomorrow's lawmakers to increase the deficit further or to anger voters by allowing the benefits to lapse.
Economists overwhelmingly agree on the wisdom of running deficits during downturns, particularly one that has raised fears of deflation. "The deflation scenario is so dangerous," said J. Bradford DeLong, an economist at the University of California at Berkeley, "we want to take every step we can to avoid it."
What makes the slump of the last three years unusual is that spending by consumers stayed strong, which means they will be less likely to supplant the government as the main engine of growth once taxes increase or federal spending falls in future years.
Consumers have typically emerged from past recessions with a pent-up desire for houses, cars and other big-ticket items they avoided buying during tough times. This time, an aggressive series of interest rate reductions by the Fed has helped make many of those items affordable even as wage gains have all but stopped, after inflation is taken into account.
In trumpeting the Fed's vigilance against deflation in recent weeks, Mr. Greenspan has ensured continued low interest rates. Bond traders now believe that short-term rates, which the Fed controls, will remain low for months, and they have reacted by lowering long-term rates. Thus, last week, mortgage rates plunged to record lows, making it more likely that the refinancing boom will continue.
"This is obviously not going to go on forever," said Jan Hatzius, a senior economist at Goldman Sachs. The recent growth of consumer spending, he added, "is sustainable as long as households are able to take more and more equity from their homes."
The one recent attempt at resuscitation that economists say is likely to bring future benefits is the dollar's decline, which has accelerated since Mr. Snow suggested he was not bothered by it. By contrast, the Clinton administration occasionally bought dollars in the currency market to bolster their value, hold down the price of imports and keep inflation low when the economy was growing rapidly.
Now, however, a little inflation does not look so bad.
Even before the dollar's recent fall, the corporate sector was the only big part of the economy that has used the slowdown to bring its debts better into line with its assets. While the market's fall brought down the net worth of consumers by 10 percent from the start of 2000 to the end of last year, the net worth of nonfinancial companies rose almost 5 percent, according to the Fed.
Pointing to benefits from the dollar's fall, many economists say they expect corporate executives will soon end their cost-cutting ways of the last three years and decide that they can profitably use new factories and new technology.
That is a reason to think the economy will improve before the year ends, as almost every forecaster is predicting. By itself, however, it might not be enough to restore the economy to full health.
