Washington's Last Hope to Prod Economy

Washington has only one course left to give the sluggish economy a badly needed shot of adrenaline: to hammer out a credible plan to pare back the long-term deficit. With the recovery at a plateau and housing still in a deep slump, economic growth has slowed to a crawl. And job creation still is weak. Although few analysts expect a second recession, economists are downgrading their forecasts, predicting that output will stay sluggish all year — and possibly through 2014 or later.

What’s more, public disillusionment over the pace of the two-year-old recovery, combined with widespread worry over the massive federal budget deficits being projected for the next decade, has spawned growing uncertainty and a lack of confidence about the outlook. Both consumers and businesses are holding back, waiting to see whether the economy will get better or worse before committing to hiring and purchasing decisions.

Uncle Sam’s traditional array of stimulative fiscal and monetary measures has been stripped clean. The White House has exhausted its primary tool for digging out of a slump: injecting more fiscal stimulus into the economy. The administration has gone through some $800 billion in spending and tax relief, and hasn’t a prayer of winning congressional approval for a second round.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

At the same time, interest rates are already near zero, and the Federal Reserve has ended its “quantitative easing” program of buying up Treasury securities to pump more money into the economy. It won’t ease the money supply again for fear of intensifying inflation and driving down the value of the dollar. “Monetary policy cannot be a panacea,” Fed Chairman Ben Bernanke warns.

A serious plan for dealing with the deepening chasm between federal revenues and government spending is the only means left for policymakers to deal with the uncertainty and lack of confidence plaguing the economy. But here, too, the government’s machinery seems paralyzed. Even if congressional negotiators can agree on enough budget cuts to pass the debt ceiling bill, the deficit reduction package is likely to be modest, with little real impact on the critical longer-term budget problem.

The package of spending reductions now being discussed won’t even touch the big-ticket changes needed to put the nation’s fiscal house in order: paring back Medicare and other federal entitlement programs, overhauling the federal tax code, revamping the nation’s mortgage financing apparatus and spurring new oil exploration. Both parties are prisoners of their own strident rhetoric.

If the negotiations turn out as expected, lawmakers most likely will simply kick the controversy down the road once again, this time until just before the 2012 election. That will leave both parties even less enthusiastic about hammering out a serious budget plan than they are now.

As a result, there’s a growing fear among economists that the United States may be heading for the kind of lost decade that Japan experienced through the 1990s, after its financial bubble collapsed, leaving the economy anemic, with no way for policymakers to get out of the slump. Eventually, Japan’s problems worked themselves out, but it took years.

Both the nonpartisan Congressional Budget Office and the International Monetary Fund are predicting that economic growth in the United States will remain at about 2.5% a year for the foreseeable future. That’s sufficient to avoid tipping back into a recession, but not strong enough to bring down the jobless rate, now hovering at about 9% of the workforce.

And this time, the U.S. cavalry isn’t going to ride to the rescue.