What If There's Another Dip?

Sadly, there is the all too real risk that the United States will experience a double-dip recession in the second half of 2010 once the present fiscal stimulus support to GDP growth fades. Underlying this risk are the strongest of headwinds currently confronting the US economic recovery with little sign that any of these headwinds will soon abate.

The most serious of the headwinds is the present appalling state of the U.S. labor market as epitomized by an unemployment rate, including discouraged workers and those involuntarily in part-time employment, which now exceeds 17 percent. The maintenance of such an extraordinarily large labor market gap in 2010 is bound to substantially constrain wage income growth at the very time that households are in the process of deleveraging. In addition, in 2010 the U.S. economy will need to cope with a dysfunctional financial system that is still cutting back on lending, especially to consumers and to small- and medium sized businesses; a commercial property market that is about to be hit by US$500 billion in maturing loans; and a housing market that is more than likely to experience another leg down due to a still rising wave of home foreclosures.

If there is anything that we should have learnt from our 2009 experience, it is that the last thing that the U.S. economy now needs is another botched fiscal stimulus package. Our now highly compromised public sector finances simply cannot tolerate another expensive, back-loaded, and pork-laden stimulus package without inviting a real backlash in the bond market and without risking a full-blown dollar crisis. The Congressional Budget Office is already projecting that over the next decade the US budget deficit will remain in excess of US$1 trillion a year as a result of which the United States will experience the largest ever peace-time build up in the U.S. public debt.

With interest rates already at zero and with markets signaling unease about further quantitative easing, there would appear to be little further that the Federal Reserve can do to support the economic recovery. A fading U.S. economy could now benefit, however, from a fiscal stimulus subject to two very important provisos. The first is that the fiscal stimulus were to be truly timely, targeted, and temporary. The second is that the stimulus package were to be accompanied by credible and concrete measures that convincingly demonstrated to markets how medium sustainability was to be restored to the U.S. public finances.

Desmond Lachman is a resident fellow at AEI.

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

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