Recovery slows down as stimulus funding expires

The U.S. economic recovery downshifted dramatically this spring as various stimulus measures enacted by Congress ended or started to wane.

The sudden softening of growth, which also coincided with the outbreak of a debt crisis in Europe, is prompting many economists to caution against withdrawing stimulus too soon, and some are even calling for another round of government action to prop up the economy for a while longer.

The downshift was most dramatic in the housing market, where the April 30 end of a tax credit for signing a purchase agreement caused an unexpected collapse in sales to record lows. But reports last week also showed a slowdown in manufacturing, which had been leading the economic recovery, and a second month of tepid private job growth in June.

News of a major slowdown in China’s economy also added to doubts that the U.S. could continue to rely on export-led growth. The accumulation of reports sparked worries in financial markets that the loss of momentum means the economy is in danger of going into reverse, prompting a drop in major stock indexes to their lowest levels of the year.

“This economic recovery doesn’t have enough momentum to sustain on its own without government help,” said Sung Won Sohn, an economics professor at California State University at Channel Islands.

“A Catch-22 situation” has developed as businesses hear talk of a double-dip recession and put off hiring for fear of what the future holds, he said. Their reluctance to take on workers results in weak growth in incomes and jobs, providing little fuel for consumers to keep spending and supporting the economy.

“Housing is in a double-dip recession,” and spending cuts by states and local governments will drag down the economy further over the next year, he said.

State and local spending on public construction projects has been a source of strength since the $862 billion stimulus bill was passed last year, but that will start to wane in coming months and result in further layoffs of construction workers, he said.

“The Obama administration could consider another set of targeted stimulus for the long-term jobless, housing, state and local governments and small business,” he said.

Congress recently passed legislation extending until Sept. 30 the June 30 deadline for home buyers to close on the sales, though a purchase agreement still has to have been reached by April 30 for the tax credit to apply. It also has approved legislation to stimulate bank lending to small businesses.

But a measure to extend benefits for the long-term unemployed and provide aid to state and local governments has become mired in a fight between congressional Democrats and Republicans over whether the spending should be offset with cuts elsewhere in the budget.

Democrats say the economic slowdown represents an emergency and Congress need not fully offset the job measures. But Republicans are pushing to use unexpended funds from the stimulus bill, which might mean cuts in infrastructure projects later this year.

“The economic recovery is hitting a rough patch at midyear,” said David Huether, chief economist at the National Association of Manufacturers. “Part of the slowdown is being driven by a number of government stimulus programs that have either expired or are slowing down. … Employers believe a self-sustainable recovery is not as strong as it was a few months ago.”

Although the economy might be able to sustain itself, a growing number of economists say the government should do more — or at least put off efforts to start trimming stimulus — to ensure it doesn’t relapse into recession.

“Many countries are rapidly scaling back stimulus spending in an attempt to rein in their own official deficits,” said Bernard Baumohl, chief global economist at the Economic Outlook Group.

“There’s the fear such synchronized austerity across countries in Europe, along with Japan, and China may bring the world recovery to a screeching halt,” he said, adding that he is no longer as optimistic that the U.S. economic recovery will continue on its own.

Still, it is difficult to imagine what else the U.S. government could do to foster growth in an area like housing, he said, which already receives extensive government support, including the backing of the U.S. government on nearly every loan written to buy houses today.

“Is the economic medicine working? Yes, but it can only go so far,” he said. “If the lowest mortgage rates in history and plunging residential real estate prices are not enough to get even Americans who are working to go out and buy, what will?”

Republican economists say that more stimulus spending is not the answer.

They say small businesses, which ordinarily do the most hiring in the U.S., have been spooked by the heavy-handed regulatory programs that President Obama and the Democrat-led Congress are enacting and/or considering, and are holding off hiring because of that.

“Its natural that employers are afraid to hire since their taxes will go up on January 1, 2011; their energy bills will rise if Congress passes President Obama’s requested cap-and-trade legislation; their ability to borrow will decline if the financial regulation bill is signed into law; and, if they have a work force of more than 50, they will face a $2,000 penalty per worker if they don’t provide the right kind of health insurance,” said Diana Furchtgott-Roth, senior fellow at the Hudson Institute and former chief economist at the U.S. Labor Department.

She said Congress should consider “lower taxes, lower spending, and less regulatory red tape” to stimulate the economy.

“Prior efforts to stimulate with deficit spending, absurdly low interest rates, and a series of government programs designed to support the housing and automobile markets have failed to create any meaningful forward momentum,” said Peter Schiff, president of Euro Pacific Capital and a Republican primary candidate for Connecticut’s 2010 U.S. Senate seat.

If Congress takes the current economic weakness as a cue to simply spend more, it could lose the confidence of investors in U.S. debt, he said. The economy’s problems grew out of too much spending and debt in the first place, he said.

“Any new stimuli, in the form of greater deficit spending … should be considered economic sedatives rather than stimulants,” he said.